Gone are the days that someone joins a company out of college, grows with the same employer throughout their career, and then retires off into the sunset with a nice pension. Now, people move from job to job more frequently, and more often than not, they will have to rely on their own retirement savings from 401ks and IRAs to cover their retirement cash needs.
Clients at Glassman Wealth Services ask us all the time, “What should I do with my old 401k?” Before you do anything, you should know your options to avoid mistakes that could result in higher taxes, penalties and fees.
Here are 6 important options and points to consider when leaving a company where you have a 401k account:
1. Roll your 401k to a IRA (Individual Retirement Account) account:
This is usually the default option we recommend to our clients for several reasons. Many 401k plans have limited fund options, and those funds, often times, have higher management fees than IRAs. IRAs can be opened at many different custodians (ex. Charles Schwab, Fidelity, Vanguard, etc.) and have virtually unlimited investment options.
An investor can simplify with low cost index funds, invest in active mutual funds or exchange traded funds, or even pick individual stocks for their portfolio. This flexibility is the primary reason to roll your 401k to an IRA account.
2. Roll your old 401k to your new 401k:
If you’re going to remain employed and you’re happy with your new employer’s 401k plan and options, it may make sense to roll your old 401k into your new plan. Consult with your new HR department to confirm that rollovers are permitted.
Moving the funds to your new 401k will allow you to keep all of your retirement assets in one account and simplify your portfolio. If you’re older than 70 ½ and still working, then there are additional advantages. (I discuss this later.)
3. Keep your 401k with your former employer:
If your former employer has a terrific 401k plan with lots of investment options, you may consider leaving it where it is. It’s important to consider any administrative fees that your former employer may pass on to its employees because they eat into your overall return.
In some states, 401k plans offer better creditor protection than IRAs, so if that’s a concern, it may make sense to keep the funds where they are.
You should consider these important points before making your rollover decision:
4. If you’re over 70 ½ and still working:
All individuals are required to begin taking required minimum distributions (RMDs) from their traditional IRA accounts when they turn 70 ½. Beginning in 2020, RMDS begins at age 72. This terrific RMD Guide explains what you need to know about RMDs.
If you’re not a 5% owner in a company and still working at 70 ½ (72 after 2019), then your 401k is not subject to these RMD rules as long as you continue to work.
This can be extremely advantageous for some employees who want to continue working and want to reduce their taxable income.
5. If you have company stock in your 401k: STOP AND READ THIS:
If you roll appreciated company stock from a 401k to an IRA, the entire gain will be taxed at your ordinary income tax rate when you withdraw it.
However, if you have a triggering event, like turning 59 ½ or losing your job, you can elect to move the company stock to a taxable account and roll the rest of the account into an IRA. You’ll have to pay ordinary income tax on the basis of the stock upon transfer, but the growth over the basis (the net unrealized appreciation) will be taxed at the more favorable capital gains rate only when you sell the stock.
Ed Slott’s article, New Approach to a 401(k) Tax Tactic explains the pros and cons in more detail. I recommend that you talk to your financial planner or accountant to understand which option is best for you.
6. If you have a pre-tax 401k and a Roth 401k:
Congratulations, you were able to take advantage of the Roth 401k feature your plan offered! Now, it’s important to keep those dollars segregated. If you decide to rollover your 401k dollars into IRA accounts, make sure you establish two accounts, a traditional IRA for the tax-deferred 401k dollars and a Roth IRA account for the Roth 401k dollars. Your 401k provider will be able to give you the current accounting for each type of contribution.
DON’T TAKE THE EASY WAY OUT! Often times, especially with younger employees, they see their retirement dollars as a windfall to spend. They leave a company and cash out whatever dollars they have saved in their retirement accounts not thinking about a retirement that’s 20-30 years away. Not only does this create taxable income and a 10% penalty, but it puts that individual behind in their retirement savings. It’s difficult to make up that savings deficit as people get older.
Leaving a job, whether retiring or just moving to the next opportunity, can be a hectic and scary time. Relax, keep things simple, and work with your financial advisor and HR department to come up with the best decision that makes the most sense for you and your retirement.
If you have questions about rolling over your 401k account and would like to speak with an advisor, please Contact Us.