As you transition between employers throughout your working career, make sure that you don’t leave a trail of former employers’ retirement plans in your wake. Losing track of old plans is a legitimate concern, and it can be easy to fall into the trap of “out of sight, out of mind.” As time goes by, companies can merge or even go out of business, they also might change custodians for their retirement plans. Your contact information will also likely change and must be kept current with the former plan. Here are tips on managing and protecting your retirement plans.
Options When You Leave a Job
There are four options available to you for your 401(k) plan when you leave a job:
- Leave it with the former employer if your account balance is large enough. Leaving a retirement plan account with the former employer is the default option that many people elect. It’s certainly easy when you change employers, but it’s important to ask yourself if you will be mindful to monitor the investments relative to other accounts such as a new retirement plan. An important note is that the minimum balance requirement is typically $5,000. Be careful if you fall under the minimum, as they may simply payout your account balance, which could result in a taxable event unless properly deposited into a qualified retirement account.
- Cash it out. Please do not do this! This will be a taxable distribution and you could be subject to additional 10% tax penalties if you are under the age of 59½. Cashing out might seem tempting if your account balance is small. However, if you change jobs frequently, you could have a series of small balances from former employers’ retirement plans. Over time, with the power of compounding, those combined balances can make a big difference. Retirement savings are too important to cash them out prematurely, even small single account balances.
- Roll it over into your current employer’s 401(k) retirement plan if this is permitted. This option can help to consolidate your accounts within your new employer’s retirement plan. However, you should consider the quality and breadth of the investment options available in your current employer’s plan, the underlying investment expenses, as well as any administrative fees when making this this decision.
- Roll it over into a new or existing IRA account. By consolidating your former 401(k) accounts, you’re less likely to lose track of an old account. Most people roll the money over to an IRA because they want access to more investment options and to have more control over the account. They are also looking for lower fees and simplification. Moving your money to an IRA can also help streamline your investments. Look for a custodian with low fees and a wide selection of low-cost investment offerings. You can also hire an investment advisor to assist you with decisions, helping to ensure your investments properly align with your financial needs, goals, risk considerations and more.
Account Consolidation and an IRA Rollover
If you are looking for ease of management and to simplify your financial life, reduce the number of your retirement accounts. The benefits of account consolidation include easier tracking of investment performance and monitoring of asset allocation, simplified tax documents and statements, simplified cash flow management, and an easier time managing your Required Minimum Distributions (RMDs) when the time comes. It’s also easier to keep beneficiary designations up to date. There could be cost benefits, since larger accounts often qualify for discounts.
An IRA Rollover account can offer more investment choices, lower fees, and costs. Tax deferral benefits continue, allowing your retirement savings to grow tax deferred.
The custodian of your former employer’s retirement plan will often make it very easy for you to rollover your former 401(k) Plan account into a new IRA at their institution. This might be an attractive option, especially if you do not already have an IRA account elsewhere. However, it’s important to make sure that you evaluate the individual merits of that custodian. Also, beware of a proliferation of IRA Rollover accounts at different institutions if you continually take the path of least resistance at a variety of custodians. This defeats the purpose of account consolidation. IRAs should also be consolidated where possible.
The Correct Way to Do A Rollover:
A rollover is not a taxable event. When rolling funds from an employer-sponsored plan to your IRA, you can avoid mandatory tax withholding by requesting a direct rollover. Make sure that you elect a “direct rollover” or “trustee to trustee transfer” as the type of distribution.
With a direct rollover from an employer-sponsored plan to an IRA, the administrator of your plan delivers your distribution directly to the financial provider where your Rollover IRA is held. Since you never actually take possession of your assets, there is no taxable event. In some cases, a check may be mailed to you, however, it should be made payable directly to your new trustee or custodian. You then deposit that check into your IRA account. Since it is payable to the trustee or custodian, and not payable to you, you have not been deemed to have taken possession.
Keeping Your 401(k) Account as Is
Under certain circumstances, it can make sense to leave your 401(k) account with your former employer:
- The IRS Rule of 55 allows an employee who is laid off, fired/terminated, or who quits a job between the ages of 55 and 59½ to withdraw money from their employer’s retirement plan without incurring the 10% tax penalty for early withdrawals. If you will need to tap these funds prior to age 59½, this is a very attractive benefit. It does not apply to withdrawals from an IRA.
- For creditor protection. Unlike IRAs, pension plans, such as 401(k)s and 403(b)s, are protected by the Employee Retirement Income Security Act of 1974 (ERISA). One of the law’s protections is that creditors cannot seize your investments. Employer-sponsored retirement plans provide broader creditor protection under federal law than is provided with an IRA.
Creditor protection afforded to IRA accounts depends on state statutes and the type of IRA account. For example, Virginia’s creditor protection limit for IRAs was up to $1,362,800 in 2019 (adjusts for inflation every 3 years).
- If there are strong investment options, such as institutional funds and closed funds, that you would not otherwise have access to. The bigger 401(k) plans have access to institutional-class funds that charge lower fees than their retail counterparts.
The decision about what to do with your former employer’s retirement plan is an important one that can also have tax consequences. Consult with your tax advisor or financial advisor to get advice before acting. SageVest Wealth Management counsels clients on the all aspects of investment and retirement planning, including appropriate decisions regarding former retirement plans. We invite you to contact us for more information.