For some people, changing jobs is an annual occurrence, such as my one friend who has been employed by every major bank since leaving college a decade ago. For others, it is stressful and unnerving. You might have gotten laid off or on the flip side, took advantage of a better opportunity. In any event, you’ll most likely wonder what your options are for your 401k that you were funding at your previous employer.
Well, you have some options, so let’s dive in, shall we?
Here are your four main choices for your 401k when leaving an employer, along with some positives and negatives associated with each:
- Keep it where it is. Let’s start with the simplest choice. Doing nothing. You can certainly leave your 401k where it is as long as you have over $5,000 in it. Below that and they may make you move it. The only time we will recommend this option is as a short-term solution for when the individual is between 55 - 59.5 years old, as there is an opportunity to take money without penalty if need be. Other than that, one of the below options is usually better depending on your situation.
I’ve seen many individuals leave a job and forget that they had a 401k there. Years later, it’s still at their previous employer, not being managed and forgotten. That is your money. Make sure you take it with you.
Tax Impact: None.
- Withdraw the money and cash it out. Most often the worst choice. Taking money from your qualified account (401k) prior to age 59.5, without an exception, will bring along a 10% penalty as well as income taxes. Not to mention you’ll also be taking money away from an account that was earmarked for retirement. If you REALLY need the money, consider leaving it in your former employer’s 401k and take a loan. That is a conversation for another day.
Tax Impact: Income taxes and 10% penalty (if under 59.5 years old).
- Rollover your previous 401k into your new 401k. The positive is that you’ll now have all of your retirement dollars in one account. The downside is that you’ll have the limited investment options available with your new 401k, which could also be more or less expensive than your last plan.
Tax Impact: None.
- Rollover your previous 401k in your own IRA. This is the option we most times recommend. If you are a do-it-yourselfer you can open up an IRA at a low-cost broker such as Fidelity or Vanguard. If you don’t want to manage your investments yourself I suggest reaching out to a Financial Advisor for assistance. They’ll be able to not only help you choose the best option, but also tailor a portfolio that fits with your goals, timeline, and risk tolerance.
Tax Impact: None.
IMPORTANT: If you are choosing either option 3 or 4, you have two choices:
Direct Rollover: The simplest way to do any rollover is DIRECT. This is when your previous employer’s 401k plan administrator directly transfers your 401k to your new IRA institution or new 401k plan administrator. You never touch the money.
Indirect Rollover: Not complicated, but an extra step is involved with an INDIRECT rollover. This is when your previous employer’s 401k plan administrator makes a check out to your new IRA institution or new 401k plan administrator, but mails it to you instead of sending it to the new institution. Here, you take control of the funds and send them to their new destination personally.
60-Day Rollover Rule
Once the money comes out of your former 401k plan, they must be deposited into your new 401k plan or IRA within 60 days. If you do not get it in within 60 days, the IRS counts these funds as income, which bring along with it income taxes since it has never been taxed, as well as a 10% penalty if you are under 59.5 years old. This mainly comes into play with Indirect Rollovers.
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Fun Fact: Ronald Wayne was the third cofounder of Apple, along with Steve Wozniak and Steve Jobs. In 1976, he sold his 10% share of the company for $800. Today, his 10% would have been worth of $35 billion. Tough sledding, Ron.
Disclaimer: This is meant to be general information and is in no way a recommendation for any investment product.