It’s more common than ever for individuals to make a career change or hold multiple positions during their core money-making years. The combination of people making career moves and 401k plans being a common retirement benefit leads to the natural occurrence of many old 401k plans not actually managed.
If this is you, you probably have a general idea of your balance and your last contribution was likely tied to your last paycheck with the plan sponsoring company. Despite that, your account has still hopefully been working on your behalf depending on how the funds were invested.
Once you leave a company with a 401k, it’s up to you to manage the account going forward. This overview intends to provide an understanding of your options. Remember, 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. Remember to distinguish between a Roth or Traditional 401k, transferring funds into the matching type of IRA is a simple process but each has their own tax implications.
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. Your money and the gains grows tax-free. Withdrawals of the initial investment and gains are not taxed.
While you can access the funds you deposited at any time, there are penalties associated with early withdrawals of gains. Once the rollover is complete, you can continue contributing up to $6,500 per year into your IRA (or $7,500 if you’re 50 or older). An IRA is a great way to continue saving for your retirement while reducing your lifetime tax bill.
A standard rollover should not trigger a taxable event. While the transaction will be recorded with the IRS, transferring funds directly from your 401k to the IRA is the way to go. To ensure this, we recommend making sure there is not a check for the 401k funds issued to you personally in your name, it must be sent directly to the new IRA.
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 and in many ways, mirrors the process of rolling over into an IRA.
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 $5,000 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 have more than $5,000, and 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.
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 that understands your goals and keeps your tax scenario at the forefront of financial recommendations. 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 today:
About Integrated Wealth Management
Integrated Wealth Management is owned by Burt Hutchinson, CPA, CFP®. We’re a CPA-led organization, meaning we’re here to handle your complex tax scenarios and provide cost-saving insight related to your financial plan.
We’re here to guide you through the 3 stages of retirement:
Uncertainty Stage: When you are within 10 years of retirement and have questions about how to make it work
Stability Stage: When you have reached the financial milestone to retire comfortably and confidently
Reflection Stage: When you are looking to leave a legacy
We are also here to provide experienced, empathetic support during times of loss, such as the death of a life partner. You need confidence and a sense of security to enjoy retirement. As fiduciaries with a fee-only structure, we never receive commissions. Free of ulterior motives, you can be sure we’re focused on your goals.
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Disclosure Statement:
This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax, or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice.
Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website, Past performance is not a guarantee of future results.