If you have a 401(k) plan, you are familiar with the benefits afforded by these popular retirement accounts. They are a great way to set aside pre-tax earnings and enjoy tax-deferred investments that have the potential to grow over the years, especially if your employer matches your contributions.
But what will happen to that nest egg if you leave your company to take another job? Maybe little or nothing at all, if you transfer the money to another qualified plan. Or, you might face a big tax bill and a government penalty if you prematurely withdraw funds.
Employees who leave their companies have several options when it comes to their 401(k) plans, and each option has advantages and disadvantages.
Keep your old 401(k) where it is and start another one at your new job
This option avoids the possibility of taxes and penalties, and your money will continue to grow tax-deferred. Another potential advantage is this: If your old and new companies offer plans with different—yet complementary—investment options that meet your needs, you will be able to enjoy the benefits of both plans.
Before making any decision, ask your former employer if your access to money in the existing 401(k), such as borrowing against it, will be restricted once you leave the company. It should also be noted that another possible drawback to having two accounts is just that—there will be two sets of records to track.
Roll over existing 401(k) assets to an IRA and start another 401(k) at your new job
This approach has one important potential advantage: Your investment choices may be broadened since Individual Retirement Account (IRA) assets can be invested in thousands of individual securities or mutual funds. By contrast, many 401(k) plans offer only a handful of options.
There are, however, some potential disadvantages to this approach. First, you cannot borrow against money in an IRA the way you can with many 401(k) plans. Second, as mentioned earlier, you will have to monitor two separate accounts.
Also, keep in mind that, if you choose this option, the money should be rolled over directly from the 401(k) to the IRA. If the money goes to you, your former employer will withhold 20% for federal tax, even if you put the money into an IRA within the 60-day period allowed by the Internal Revenue Service (IRS). While it is true that you may be able to get the withheld money back in the form of a tax refund, the money will not be working for you during the time that it is not in your account.
Finally, remember that if you have already borrowed against your previous 401(k) plan, that loan will probably come due soon after you transfer your 401(k) money to the IRA.
Close your existing account and move your assets to your new employer’s 401(k)
Many companies permit a simple transfer of assets from one 401(k) to another. One benefit of this option is that you will incur no taxes or penalties and your money will continue to grow tax-deferred. The option is especially attractive if your new company offers better investment choices than your former company. Plus, you will have only one set of account statements to track.
It should be noted that while some companies allow new employees to transfer the money right away, others require you to wait a period of time before becoming eligible to enroll.
Take some— or all—of the money and run
It is quite tempting to take a 401(k) distribution in cash to pay for a dream vacation, a new car, or some other treat. But cashing in a 401(k) carries serious consequences and is not a good option for most people.
If you are younger than age 59 ½, all pre-tax contributions that you take as a distribution will probably be subject to ordinary income taxes— federal, state, and local— and a 10% IRS penalty. Plus, unlike a loan from a 401(k), money that is withdrawn from a 401(k) can never be put back. A loss of all, or a large chunk, of your savings may severely diminish your ability to meet your financial objectives for retirement.
However, if you are leaving your existing employer and the balance of your 401(k) is less than $5,000, your employer has the right to authorize distribution of funds from that plan. You can then use the funds to open your own IRA. Because each plan is written differently, it’s important that you consult with your employer and your tax advisor to find out what the best options may be for your situation.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, investment, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.