Often touted as a defining characteristic of the Millennial Generation, Americans these days are shifting from job to job at a staggering rate. In 2014, the Bureau of Labor Statistics reported that the typical US worker stayed on the job for 4.6 years1.
Another report published in 2015 by the US Labor Department notes that the average worker holds 11 jobs from age 18 to 482. With the rising popularity of 401(k) plans instead of traditional pension plans, many employees gather up quite an assortment of 401(k) accounts as they move from job to job.
What Are Your 401(k) Plan Options?
Many people aren’t sure what their 401(k) choices are when they leave a company. When it comes to company-sponsored 401(k) retirement plans, there are five different options available to you when you leave an employer, and your decisions may be based on whether you have before-tax contributions, after-tax contributions, or both:
1. Leave the plan with your previous employer.
This is the easiest option because it doesn’t require you to take any action. However, it might not be an option for everyone. If your account holds less than $1,000, your employer is permitted to automatically cash out your account when you leave. If your account holds between $1,000 and $5,000, most companies will automatically roll your account into an IRA for you when you move to a new job. Most people need to have over $5,000 in their account to have the choice of leaving it in place.
There are a few benefits to keeping your money with your previous employer. If you turned 55 before leaving the job, then you can take penalty-free withdrawals before turning 59 ½. With the company plan, you may have lower priced or unique investment options that will no longer be available to you if you move the money. Also, because of federal law, your money is safer from creditors in a 401(k) plan than in an IRA if you go through bankruptcy.
Unfortunately, there are some downsides to leaving your money behind when you move on. You will no longer be able to contribute to your plan or take a loan from it. You are limited to the investment options the company offers, which may have higher fees or lower returns than you can find elsewhere. You are also limited in your withdrawal options. Instead of taking a partial withdrawal you may be forced to take the whole amount. If you like having your money in a 401(k), but don’t like your old company’s plan, there is another option.
2. Move your 401(k) money into your new employer’s plan.
Not all companies accept rollovers from other plans, so you will have to consult with your new plan administrator to see if this perk is available to you. People often choose this approach as a way to consolidate assets into one account instead of having multiple small retirement accounts lying around.
Most of the advantages of moving your money into your new employer’s plan are the same as keeping it in the old one, such as creditor protection, possible lower-cost investment options, and unique, plan-specific investment options (which vary by plan). Also, if the plan allows, you can take a loan against your account, although it is important to remember that it is due in full when you leave that job. The disadvantages to this approach are also the same as the previous option; you are limited in your investment options and subject to the plan rules, which may have certain transaction limits.
3. Cash out the account.
Although a 2012 report by Transamerica Center for Retirement Studies showed that 25% of unemployed or underemployed workers chose this route, it is almost never a good idea. Withdrawing the funds from your 401(k) account before you are 59 ½ obligates you to pay ordinary income taxes on them as well as a 10% early withdrawal penalty. For someone in the 25% federal income tax bracket paying 7% state income taxes, a $50,000 cash out would cost them $21,000 in penalties and taxes.
That means essentially forfeiting 42% of your money so that you can have it now instead of later. The only exception is for people who are 55 or older when they leave their job. They still have to pay income taxes on the money, but the penalty is waived. If you find yourself desperate for money, even a loan with 30% interest would be cheaper than cashing out your 401(k) account (if you are under 55).
4. Rollover your 401(k) into an IRA.
When considering what to do with old 401(k) accounts, many people choose to roll them over into IRAs, or Individual Retirement Accounts. These accounts differ from 401(k)s in a variety of ways. First of all, when you are an IRA account holder, you are the full owner. Whereas with a 401(k) account, the plan trustee owns the assets. Also, unlike your 401(k), your IRA is not tied to a particular employer, therefore changing jobs has no effect on it. A disadvantage of this approach is that you don’t have as much protection from creditors with an IRA as you do under a 401(k) plan.
There are many advantages to having your money in an IRA as opposed to a 401(k) plan. You have much more flexibility with the IRA. You can shop around for low fees and reliable investment options. Instead of being tied to the 20 or so options your company offers, you can invest your IRA in just about anything except life insurance or collectibles. You can even invest your IRA in real estate that you manage through a self-directed IRA. IRAs usually offer much greater flexibility as to whom you can name as a beneficiary or contingent beneficiary of the account.
When you roll all of your old 401(k) accounts into an IRA, you can keep adding money to the account, no matter who your employer is in the future. With all of your money in one place, it’s much easier to see the big picture of where you stand financially and manage your asset mix. The IRS even allows you to withdraw earnings penalty-free from your IRA before you turn 59 ½, as long as your account has been open for five years and the money is used for qualified expenses, such as buying your first home, higher education, or medical expenses.
5. Rollover and convert to a Roth – great for after-tax money.
You also have the option to convert a 401k directly to a Roth IRA. This is especially nice for the after-tax portion of your IRA. Since taxes have already been paid on this type of contribution, moving it to a Roth, where it can continue grow tax free and come out tax free makes good sense. Previous to a 2016 rule change, the process was multi-step, so many investors simply cashed out their after-tax money, missing out on future tax deferrals.
When converting before-tax money to a Roth, taxes will be owed upfront for the year of the conversion amount. Roth money is considered “qualified” once it has been held for 5 years and the owner is 59 ½. Distributions not held for the five years will be subject to the 10% early penalty, if withdrawn before 59 ½. No matter the source of funds, Roth IRA’s do not have minimum distribution rules starting at 70 ½ like regular IRA’s.
As always, it is a good idea to consult with an experienced financial professional when making changes to your retirement savings plan. A qualified professional can help you understand your options and how they relate to your specific situation, as well as walk you through the process. If you have an old 401(k) account, call our office at (770) 436-4097 x108, or email me at jerry@southbridgeadv.com I will help you decide the best course for your goals and situation.
About Jerry
Jerry Sniderman is a partner and Wealth Advisor of Southbridge Advisors, an independent wealth management firm serving individuals and businesses near Atlanta, Georgia and throughout the country. As an experienced financial veteran, Jerry offers broad expertise in wealth management services including asset management, fiduciary consulting, retirement, trust and estate planning, as well as insurance and 401(k) plan services. To learn more about how Jerry may be able to help, visit the Southbridge Advisors website, call his office at 770.436.4097 x 108 or email him anytime at jerry@southbridgeadv.com.
_________
1 "Employee Tenure Summary." U.S. Bureau of Labor Statistics. September 18, 2014. Accessed June 15, 2016. http://www.bls.gov/news.release/tenure.nr0.htm.
2 "Number of Jobs Held, Labor Market Activity, and Earnings Growth Among the Youngest Baby Boomers: Results From a Longitudinal Survey." Bureau of Labor Statistics. March 13, 2015. Accessed June 15, 2016. http://www.bls.gov/news.release/pdf/nlsoy.pdf.