If you’re nearing retirement, then you likely entered the workforce around the inception time of the 401k retirement plan. While pension plans still exist in a few industries, the phasing out of pensions and implementation of the 401k is a reflection of the changing working world.
It’s widely reported that young baby boomers, born between 1957-1964, hold an average of 12 jobs between the ages of 18 to 52. While bouncing between employers is common when entering the workforce, people simply don’t stay with one employer throughout their career as often as they once did.
Changing employers comes with a change in benefits. And the 401k has become the staple retirement benefit offered by employers. The account is yours once established, and it’s up to you to manage the account after leaving.
his overview intends to provide an understanding of your options; there is no one-size-fits-all when it comes to personal finance decisions. You have the option to roll over your 401k into an IRA, roll over into a new 401k, leave the funds in your old plan, or cash out; here’s what you need to know about each option:
401k Rollover to an IRA
Your first option is to move the funds from your 401k into an Individual Retirement Account (IRA). This option provides a wide array of investment options with little or no fees. Understanding if you’re rolling over to a Traditional or Roth IRA is important for understanding the associated tax benefit.
Traditional IRA: Pre-tax dollars are deposited into the account. Funds contributed in a year are tax-deductible. Withdrawals down the road will be taxed.
Roth IRA: After-tax dollars are deposited into the account. The money grows tax-free. Withdrawals of the initial investment and gains are not taxed. We did a deep dive into the difference in one of our recent blogs, for more info reference: Roth vs Traditional — Breaking Down The Differences.
Once the rollover is complete, you can continue contributing up to $6,000 per year into your IRA (or $7,000 if you’re 50 or older). An IRA is a great way to continue saving for your retirement while reducing your lifetime tax bill.
401k Rollover to a New 401k Plan
401k plans can differ. If you’re happy with your current plan in terms of investment options and fee structure, you may wish to roll over your old 401k into your new/current 401k. A direct rollover is often advised to avoid taxes and penalty fees. In this case, the full account balance transfers out of the old and into the new.
Whenever you withdraw funds from a 401k (instead of transferred), you’re cashing out in the eyes of the IRS. “If the distribution is paid to you, you have 60 days from the date you receive it to roll it over. Any taxable distribution paid to you is subject to mandatory withholding of 20%, even if you intend to roll the distribution over later. If the distribution is rolled over, and you want to defer tax on the entire taxable portion, you will have to add funds from other sources equal to the amount withheld.”
While this indirect method is an option, a direct transfer is the easiest method to avoid taxes. This type of roll over requires you to be in touch with your prior and current plan administrators. There will likely be a form to complete, but this common transaction is an efficient way to consolidate your retirement accounts.
Leave Your Money Where It Is
You are not required to roll over your old 401k into an IRA or new 401k if the account value is $5000 or more. If you have less than $5,000 in the 401k, the money may be automatically sent to you or sent to an IRA for you. This may cause confusion about where your assets are held or if you liquidated an account. If you actively manage your retirement accounts this may be a perfectly suitable option. If you are prone to forget about the account, it may be best to transfer the funds promptly.
It’s important to note changes associated with your previous employer can affect your account. If the company undergoes an ownership change or plan change, how you access your funds will likely change. Fees and investment options are also subject to change.
Cash Out — Timing is Key
You always have the option to cash out your old 401k, but timing is everything when considering this option. If you have not met all of your retirement savings goals and you’re not yet 59 ½ years old, think twice before cashing out.
Here’s a rundown of fees associated with early withdrawals (before turning 59 ½):
The IRS requires a 20% withholding for early withdrawals. This means you’ll need to subtract 20% from your current balance to see your actual payout. This large deduction should be enough to reconsider an early withdrawal.
On top of the taxes, you’re also assessed a 10% penalty fee, further dwindling your actual payout.
While pocketing the cash may be enticing, the tax hit and penalty fee are a strong argument for not making early withdrawals from an old 401k. You’ll also miss out on any future gains you could have made from leaving the money in a retirement account.
Take the Next Step with Confidence
If you’re at least 59 ½ years old, you can start making withdrawals from a 401k without penalty. Regardless of your age, always consider tax implications. Creating a strategic plan with a financial advisor is the perfect way to orchestrate withdrawing funds from a retirement account in a manner that supports your retirement dreams.
Meet with a wealth advisor for feedback related to your old 401k, review your retirement savings, and create a plan for the future. At Integrated Wealth Management, our goal is to empower each client to make confident financial decisions. Our personalized retirement plans create a pathway to peace of mind.
To start your journey, schedule a no-obligation meeting with an advisor today: