Smart 401(k) Investing—Moving Your 401(k)
Whether you're starting a new job or getting ready to retire, you'll have to make a decision about your 401(k). You might want to consider moving your money to your new employer's plan if the plan accepts transfers. You always have the right to move your assets to an individual retirement account (IRA) or withdraw the money as a lump sum. Or you may be able to leave the account where it is. Just make sure you know the benefits and penalties involved with each choice.
Chances are, you’ll change jobs several times over the course of your career. In fact, the average US employee switches jobs 11 times before retiring. That means employees may participate in 11 different 401(k)s or other retirement savings plans during a career.
Fortunately, 401(k) plans are portable. If you switch jobs before retirement, you usually can choose among several things to do with your 401(k):
With the first three alternatives, you won’t lose the contributions you’ve made, your employer’s contributions if you’re vested, or earnings you’ve accumulated in your old 401(k). And, your money will maintain its tax-deferred status until you withdraw it. Remember, though, that if you move your money into a new employer’s plan, you’ll have to wait until you switch jobs before you can move it again.
Although you have the option of taking your money out of your 401(k) when you change jobs, taking an early withdrawal may incur a 10 percent penalty on top of the taxes you owe, while keeping your money in a 401(k) or IRA will allow it to compound tax deferred.
You do have some time to consider your options and complete transactions. By law, you must have at least 30 days to decide what to do with your 401(k) when you switch jobs.
The repercussions of taking money out now could be enormous: If you took $10,000 out of your 401(k) instead of rolling it over into an account earning 8 percent tax-deferred earnings, your retirement fund could end up more than $100,000 short after 30 years.
When You Don't Roll Over
Cashing out your account is a simple but costly option. You can ask your plan administrator for a check—but your employer will withhold 20 percent of your account balance to prepay the tax you’ll owe. Plus, the IRS will consider your payout an early distribution, meaning you could owe the 10 percent early withdrawal penalty on top of combined federal, state and local taxes. That could total more than 50 percent of your account value.
If your former employer’s plan has provided strong returns with reasonable fees, you might consider leaving your account behind. You don’t give up the right to move your account to your new 401(k) or an IRA at any time. While your money remains in your former employer’s 401(k) plan, you won’t be able to make additional contributions to the account, and you may not be able to take a loan from the plan. In addition, some employers might charge higher fees if you’re not an active employee.
Further, you might not qualify to stay in your old 401(k) account: Your employer has the option of cashing out your account if the balance is less than $1,000 (minus 20 percent withholding) and, in some cases, automatically rolling your assets out of the plan and into an IRA if your plan balance is between $1,000 and $5,000.
New Job, New Plan
|Remember, before you move your old 401(k) plan to a new plan, consider the following: |
Putting all your retirement savings into one 401(k) plan has its advantages. For example, it will make it easier for you to track your assets’ performance.
But you should evaluate your new employer’s plan before deciding to roll your assets over. Make sure the new plan has plenty of investment choices and includes the investment options you prefer. Also check to make sure that accompanying fees aren’t too high. If you’re unhappy with the options provided by your new employer’s 401(k), you can always consider your other options, including a rollover into an IRA.
Remember, too, that even if your new employer accepts rollovers, you may have to wait until the next enrollment period, or sometimes until you’ve been on the job a full year, to move your assets.
Making Your Move
If you’ve decided to roll over your former employer’s 401(k) directly into your new employer’s plan, you’ll have to:
|Watch out for the tax bite. If you indirectly roll over a 401(k), your employer will deduct 20 percent withholding from the value of your account. You have 60 days to complete the rollover.|
You can handle a rollover yourself by withdrawing money from your account and depositing it in your new employer’s plan or an individual retirement account (IRA). You may opt for an indirect rollover to take advantage of a short-term loan if you’re temporarily between jobs or you’re waiting to close on your old home to make the down payment on a new one.
However, opting for an indirect rollover as a short-term loan should be a financial last resort, since you’ll face early withdrawal penalties unless you repay the loan within 60 days.
When you indirectly roll over a 401(k), your employer gives you a check for the value of your account, minus 20 percent withholding. The IRS requires your employer to take out that 20 percent in case you decide to keep the money rather than roll it into another account. If you complete the full rollover within the time limit, the withholding will be returned to you when you file your tax return for the year. However, if you do decide to keep the money, the withholding will go towards the taxes you’ll owe on the early distribution.
Once your employer hands you your check, you have 60 days to complete the rollover. Hold the money any longer, and you’ll have taken a full lump-sum distribution whether you meant to or not.
The trick is that when you deposit your money into a new account, you must roll over the full balance of your original 401(k). So, you’ll have to replace the 20 percent that is withheld, from savings or another source, to cover the full amount that you are rolling over. Otherwise the 20 percent withholding will be treated like an early distribution, and you’ll have to pay the taxes, a possible penalty, and, worse yet, the money will no longer be tax deferred. These factors make an indirect rollover unappealing on many levels.
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