One wrong move can cost a big chunk of your savings, so you need to be ready to take the right steps.
What You Can Do With Your Old 401(k) When You Leave
If you are a job-changing employee and must decide what to do with an old retirement plan, you can leave the account where it is, roll the balance directly into a new or existing IRA or your new employer’s plan, make an indirect rollover, or take a cash distribution.
Leave Your Account Where It Is
Many companies allow you to keep your 401(k) savings in their plans after you leave your job. Often that’s only if you meet a minimum balance requirement, typically $5,000. Since this option requires no action, it is often chosen by default. But leaving your 401(k) where it is isn’t always a result of procrastination. There are some valid reasons to do it. Other reasons you may want to keep your retirement plan where it is include:
Familiar Investment Options
You may like the options in your former employer’s retirement plan, or perhaps you aren’t yet sure what to do with the money. Don’t rush. You can stick with the familiar investments until you are ready to make an informed decision.
Unique Investments and Lower Fees
Many employer-sponsored retirement plans give you access to institutional share class mutual funds and low-cost index funds, especially at large employers. You may like certain lower-cost or unique investment options in your old plan that you won’t be able to roll into or hold in an IRA.
Professional Guidance
Many retirement plans offer specialized money-management services with competitive fees that you may wish to maintain.
Protection Against Lawsuits
Employer-sponsored retirement plans provide broader creditor protection under federal law than is provided with an IRA.
Move Your Old 401(K) Assets Into a New Employer’s Plan
You have the option to avoid paying taxes (including a 10% early-withdrawal penalty tax) by completing a direct, or “trustee-to-trustee,” transfer from your old plan to your new employer’s plan, if the employer’s plan allows it. It can be easy to pay less attention to your old retirement accounts, since you can no longer contribute. So, transferring old 401(k) assets to your new plan could make it easier to track your retirement savings. Here are a few important steps to take to successfully move assets to your new employer’s retirement plan so as not to trigger a tax penalty: Step 1: Find out whether your new employer has a defined contribution plan, such as a 401(k) or 403(b), that allows rollovers from other plans. Evaluate the new plan’s investment options to see whether they fit your investment style. If your new employer doesn’t have a retirement plan, or if the portfolio options aren’t appealing, consider staying in your old employer’s plan. You could also set up a new rollover IRA at a credit union, bank, or brokerage firm of your choice. Step 2: If you decide that rolling your old retirement account into your new employer’s plan makes sense, contact the right person in your company, and ask how to make a rollover contribution. The instructions you get should ask for this type of information:
The name of the retirement plan or custodian—the distribution payeeYour account numberThe mailing address to send the money—if you receive the distribution by checkWire-transfer instructions—if the distribution can be made electronically
If you need help with the rollover, your human resources department or IRA custodian can assist. Step 3: The next move is to contact your former employer’s HR department or 401(k) administrator to request a distribution. You will need the information you obtained in Step 2. Just be sure to select “direct rollover” or “trustee-to-trustee transfer” as the type of distribution. A direct transfer is the simple option in terms of taxes and penalties. The alternative, an indirect rollover, is not as convenient. Still, direct transfers can take up to six weeks, so be patient. It all depends on how quickly your current plan administrator responds to the request.
Indirect Rollovers Can Be Complicated to Manage
With an indirect rollover, you receive a check for the balance of your account that is made payable to you. That might sound good, but as a result, you are now responsible for getting it to the right place. You have 60 days to complete the rollover process of moving these assets to your new employer’s plan or an IRA. If you don’t complete the rollover within this 60-day window, you will owe income taxes on the amount you failed to roll over. If you’re under 59 1/2, you will also face a 10% penalty tax. Indirect rollovers can be made once a year. Then, you’ll have to wait until the following year, when you can file your income tax return to actually get the withheld amount back. Suppose the 401(k) or 403(b) from your prior employer has a balance of $100,000. If you decide to take a full distribution from that account, your prior employer must withhold 20%. That means they keep $20,000 and send you a check for the remaining $80,000. You have up to 60 days to roll over the full amount of $100,000 without incurring taxes or penalties. Since you only have a check for $80,000, you must come up with the other $20,000 yourself. If you can’t, the amount you fail to roll over will be treated as a distribution subject to taxes and a 10% early withdrawal penalty if you are under age 59 1/2. Even if you have an extra $20,000 on hand, you still must wait until you file your income tax return to get the withheld $20,000 returned—or a portion of it, depending on what other taxes you owe and any other amounts withheld.
Taking the Cash Distribution May Cost You
Avoiding cash distributions can save you from taxes and penalties, because any amount you fail to roll over will be treated as a taxable distribution. As a result, it would also be subject to the 10% penalty if you are under age 59 1/2. Using the previous example, if a single taxpayer with $50,000 of taxable income were to decide not to roll over any portion of the $100,000 distribution, they would report $150,000 of taxable income for the year. That would put them in a higher tax bracket. They also would have to report $10,000 in additional penalty tax, if they were under the age of 59 1/2. Only use cash distributions as a last resort. That means extreme cases of financial hardship. These hardships may include facing foreclosure, eviction, or repossession. If you have to go this route, only take out funds needed to cover the hardship, plus any taxes and penalties you will owe.
