When you change jobs, one of the important financial decisions you’ll need to make is what to do with your 401(k). This retirement account is likely a significant part of your financial future, so handling it correctly is crucial.
Moving your 401(k) to a new employer or choosing another option requires careful consideration to avoid common pitfalls.
Let’s explore how you can navigate this process smoothly.
Evaluate Your Options
When changing employers, you generally have four options for your 401(k):
- Leave the money in your old employer’s plan.
- Roll over the funds to your new employer’s plan.
- Roll over the funds to an Individual Retirement Account (IRA).
- Cash out your 401(k).
Each option has benefits and potential drawbacks.
Leave the Money in Your Old Employer’s Plan
If your old employer allows it, you may leave your 401(k) in their plan. This option can be convenient because it requires no immediate action but has some downsides.
- Limited control : You might have fewer investment options, impacting your ability to reach your financial goals.
- Difficulties in management : Managing multiple retirement accounts across different employers can become complicated, making it harder to track your progress toward retirement.
This option might be suitable if your old plan has excellent investment choices and low fees.
Rollover to Your New Employer’s Plan
This option offers some benefits if your new employer offers a 401(k) plan and accepts rollovers.
Simplified management : Keeping all your retirement savings in one place makes managing your investments and tracking your progress easier.
Potentially lower fees : Your new employer’s plan might have lower fees or better investment options than your old plan. It could, of course, have fewer investment options and higher fees – so you will want to check this.
Eligibility concerns : Ensure that your new employer’s plan accepts rollovers and check if there are any waiting periods before you can contribute.
Rollover to an IRA
An IRA rollover is another beneficial option.
Broader investment options : IRAs offer more investment options than most employer-sponsored plans.
Control over fees: You have the flexibility to choose an IRA provider with low fees, which can significantly impact your retirement savings over time.
Access to a Financial Advisor : A financial advisor can assist you in rolling over your 401(k), which can sometimes be a labor-intensive process. By working with a fiduciary, fee-only investment advisor, these assets can act as the basis of a working relationship and give you access to a suite of financial planning services including investment consulting, retirement planning, estate planning, and more. Rolling assets to an IRA without a financial advisor puts the onus of investment selection and execution on you.
Be cautious of potential fees or penalties, especially if you’re considering a Roth IRA conversion, which could trigger taxes.
Cashing Out Your 401(k)
Cashing out your 401(k) may be appealing if you need immediate access to cash. This option is generally the least advisable due to several significant drawbacks:
Immediate tax hit : The funds withdrawn are subject to income tax, which could push you into a higher tax bracket.
Early withdrawal penalty : If you’re under 59½, you’ll likely face a 10% early withdrawal penalty in addition to the taxes owed.
Loss of retirement savings : Cashing out means your retirement funds stop growing tax-deferred, which can severely impact your long-term financial security.
Cashing out should be a last resort, reserved for extreme financial emergencies without other options.
Common Pitfalls to Avoid
Mistakes can easily have lasting consequences when transitioning your 401(k). Here are some common pitfalls to be aware of:
Missing the Rollover Deadline: When you decide to roll over your 401(k), completing the process within 60 days is critical to avoid taxable distribution. Missing this deadline could result in paying income taxes and a potential early withdrawal penalty.
Overlooking Fees and Expenses: Not all 401(k) plans or IRAs are created equal. Before rolling over your funds, compare the fees associated with your old plan, new plan, and any potential IRA.
Neglecting the Fine Print on Employer Contributions : If you’re considering a rollover, don’t forget to check the vesting schedule of your old employer’s contributions. Vesting refers to the portion of your employer’s contributions you’re entitled to keep when you leave the company. Rolling over too soon could mean forfeiting unvested funds.
Failing to Update Beneficiary Designations : Update your beneficiary designations whenever you roll over your 401(k). Life changes like marriage, divorce, or the birth of a child should prompt you to review. Update your beneficiary information to ensure your assets reach the intended recipients.
Consider Tax Implications : If you want to convert a traditional 401(k) to a Roth IRA, consider the tax implications. A Roth conversion requires you to pay taxes on the amount converted, which could be substantial, especially if you’re in a higher income bracket.
Ignoring the Importance of Diversification : When rolling over your 401(k), diversification is crucial for managing risk. Ensure your investments are spread across various asset classes to protect your portfolio from market volatility.
Final Thoughts
Transitioning your 401(k) to a new employer or to an IRA requires careful consideration and planning.
You can make informed decisions that align with your long-term financial goals by evaluating your options, avoiding common pitfalls, and seeking professional advice when necessary.
