What Should I Do With My 401(k) When I Leave My Employer?
Changing jobs could be a stressful event. Often forgotten in the transition is your employer-provided retirement plan. If you elected to participate in your employer-provided 401(k), you may not know what your options are now that you’re at a new employer. You’re left asking, “What should I do with my 401(k) when I leave my employer?”
What Are My Options?
There are several options when it comes to deciding what to do with your old 401(k): taking a withdrawal from the account, keeping it invested in the original 401(k), transferring it to your new employer’s 401(k) plan, or rolling it over into a separate IRA.
One option that some people consider is withdrawing your 401(k) balance for cash. Unfortunately, with this method there can be some unfavorable consequences:
You will incur a 10% penalty on the funds withdrawn if you are younger than 59.5 years old. There are other options available that avoid unnecessary penalties.
The balance withdrawn is fully subject to ordinary income tax which may be as high as 37% if you fall in the highest tax bracket.
Once the balance is withdrawn, that money is no longer invested tax deferred in the market which may put a dent on your retirement plan.
In general, we would very rarely recommend withdrawing one’s old 401(k) balance, because of the tax and penalty ramifications and loss of potential tax deferred investment growth.
Exploring further, you could leave your money invested in the original 401(k) plan, but here are some things to consider:
While you stay invested in the market, you cannot make additional contributions to this account anymore. 401(k) contributions are made through payroll deductions and since you are no longer with your old employer, you can’t contribute.
401(k) plans offer a limited selection of investments which can vary depending on your plan administrator. Being restricted in your investment selection can prevent you from being well diversified and often cause you to be stuck in investments with high expense ratios.
Finally, while your money stays invested in the 401(k) account, you may be subject to additional unnecessary fees and expenses from the plan administrator.
One benefit of leaving funds in your old 401(k) plan would be the ease of management and administration. Your money is already invested, and the plan administrator may add or remove investment options on your behalf. If the underlying investment fees and administrative costs are low, it might make sense to keep 401(k). A financial planner can assist you in evaluating the cost benefit of keeping your 401(k) as is or explore a different option.
Another option would be to move your old 401(k) balance into your new employer’s 401(k) plan. Before doing this however, there are a few things to think about:
As mentioned previously, 401(k) plans have limited investment options which may not always be ideal.
Every employer sponsored 401(k) plan is different, and your new plan may have higher or lower fees in comparison to your old plan.
An advantage to transferring old 401(k) funds into your new plan is being able to consolidate your retirement accounts into one. Not everyone is able to manage or keep up with having too many accounts. Moving the funds into the new 401(k) gives you the option for simpler account management. Another pro with moving the funds over to the 401(k) is that you keep the ability to take loans against your 401(k). Although we do not typically recommend taking loans from your 401(k), it could be useful if you are in a situation where you need extra cash. 401(k)s allow loans, where IRAs do not – this leads us to one of our final options on what to do with your old 401(k) plan.
One last option you could consider is a tax-free transfer from an employee 401(k) into a traditional or Roth IRA. It seems simple enough, but there are still some caveats with this process:
When you roll your 401(k) plan into an IRA, you are losing ERISA protection that is maintained in 401(k)s. ERISA was put into place in 1974 to protect the retirement assets of certain employer sponsored plans. 401(k)s typically are included in this protection. ERISA protects the retirement assets from creditors if anything was to happen. Unfortunately, IRAs do not fall under the category of the protected assets by ERISA.
As mentioned previously, once you move the money into your IRA, you are losing out on the opportunity to take out 401(k) loans. IRAs do not allow loans but if you do withdraw funds you may subject to penalties and additional taxes.
If you roll your 401(k) over to an IRA, you miss out on potentially taking advantage of a NUA (net unrealized appreciation) distribution. NUA is a tax strategy used by employees who hold highly appreciated company stock in their retirement account. When you take an NUA distribution you immediately pay ordinary income tax on just the cost basis of the stock (rather than the full distribution). The stock is then taxed at a more favorable long-term capital gains rate when sold.
Many benefits come with rolling over your 401(k) to an IRA. With an IRA, you will gain full access to the investment universe. 401(k)s limit your investment options, with an IRA you can explore the options of stocks, bonds, mutual funds, annuities, UITs, ETFs, Real estate, and infrastructure. If you decide to rollover your 401(k) into a traditional IRA, you may have the ability to make Roth conversions moving forward – a great strategy to implement if you want to avoid making RMDs once you reach the age of 72. Another advantage of rolling to an IRA is that you may be subject to lower fees depending on the investments you select. If you opt in to working with a fiduciary financial planner, they can help you select the right investments that work well with your investment philosophy while trying to attain the lowest investment expenses.
Capstone’s guidance to old 401(k) plans
Here at Capstone, working with our client’s old 401(k) plans are common. Although everyone’s situation is different, we do typically want to have some guidelines when figuring out what is the best situation for old 401(k) plans. One thing that we very rarely recommend is to completely liquidate your old 401(k) plan for cash. Aside from extenuating circumstances, the taxes and other penalties that come with taking that withdrawal are usually not worth it.
It’s always important to consider more than one option with anything in life. Certain methods may work for one person but not for another. Keeping your old 401(k) invested where it’s at may be a good temporary solution at times since it allows for ease of management while knowing that your money is still invested. If a client were to choose this option, Capstone would periodically review moving the balance over into an existing 401(k) or an IRA.
Transferring old 401(k) balances to an existing 401(k) plan may work best for others. Maintaining larger 401(k) balances allow people to take a loan against their 401(k) plan, this may be a good option for people who are in a pinch. You will also have peace of mind knowing that your 401(k) is protected and insured by ERISA.
One of the more common things that end up recommending to our clients at Capstone is to rollover the 401(k) into a traditional or Roth IRA. That is not to say that this is the best option, but it seems to work well for many of our clients. This allows us to use our strategic investment philosophy to make sure that our clients are best off when it is time to retire.
We realize how important retirement assets are to people – especially when trying to help people reach their long-term goals. Unfortunately, according to a study done by a fintech company “Capitalize” in 2021, an approximate of $1.35 trillion of assets held in 401(k) plans are left behind annually. Changing jobs frequently has become more common in America and with that, you can easily lose track of the employer sponsored retirement plans. At Capstone, we want to ensure that our clients are doing the best thing for their situation with any old 401(k) plans they may have. If you are interested in hearing more or speaking to a professional about your own personal situation, please contact us.
How To Find Lost 401(k) (cnbc.com)
Disclosures:
This article is not a substitute for personalized advice from Capstone and nothing contained in this presentation is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed by other businesses and activities of Capstone. Descriptions of Capstone’s process and strategies are based on general practice, and we may make exceptions in specific cases. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.