Job Transitions and Your Retirement Plan
If you are leaving your job and have saved for your future by participating in your employer’s retirement plan, you have a major financial decision to make: what should you do with your account? Most people have several options from which to choose. You can either cash it out and walk away with the money, roll it over into an IRA, keep it where it is, or transfer the funds into your new employer’s plan. Each option comes with benefits and drawbacks.
Cash it out
The opportunity to have a large amount of money handed to you can be very tempting! Common reasons a large number of workers cash out their qualified retirement plans (such as a 401(k), 403(b), and a 457 plan) when they leave their jobs include wanting to repay consumer debt or take a long over due vacation.
Be aware, however, that there are some downsides to cashing out your plan:
- Your former employer will withhold 20 percent of the funds for federal taxes, and then write you a check for the remaining 80 percent.
- If you are under the age of 59.5 you will have to pay a 10 percent tax penalty for the early withdrawal.
- You’ll have to start building your retirement savings again from scratch – which may not be so bad if you are very young and have decades to recoup, but if you are older you don’t have the luxury of time.
If you change your mind about taking the cash, you have 60 days to transfer the entire amount into an IRA (or into your new employer's plan, if they allow it). This is called an indirect rollover. While you won’t be assessed the 10 percent penalty, you must deposit all of the money that was in the retirement account to avoid a tax consequence. If you only transfer the 80 percent that your employer gave you, the “missing” 20 percent will be considered a distribution and that sum will be taxed as ordinary income. Deposit the entire 100 percent though, and the IRS will credit you with the amount that was held back when you file your income taxes.
The IRS will also waive the penalty if you miss the deadline because of a mistake on your financial institution’s part, or if you were too ill to meet the cut-off date.
Note: the cash in your retirement plan is not lottery winnings! It is money you have set aside for those years when you will either be unwilling or unable to work.
Direct rollover into an IRA
With an IRA rollover, you transfer your qualified retirement plan funds directly into a Traditional IRA. With these trustee-to-trustee transfers, the money is invested throughout the process, so you don’t have to deal with the tax problems associated with indirect rollovers. The 20 percent mandatory federal income tax withholding does not apply, nor does the 10 percent early withdrawal penalty.
Other benefits include:
- Rather than the limited funds in your old plan, you have a whole world of investment options open to you. IRAs allow you to invest in such vehicles as stocks, bonds, mutual funds, annuities, CDs, investment real estate, and precious metals.
- For estate planning purposes, IRAs give you flexibility in transferring funds to your beneficiaries. Your heirs can stretch withdrawals over a long period of time instead of having to take a lump sum withdrawal.
- If you use some of the money in an IRA to buy a first home or for higher education costs, the IRS will waive the 10 percent penalty (though you'll still have to pay income tax on the withdrawal).
Keep your old plan
Certainly the easiest way of dealing with the money you have in your retirement plan is to just leave it with your former employer’s plan. Many companies will allow you to remain a participant in their plan as long as you have at least $5,000 in your account.
There are a few advantages to leaving your money in an employer sponsored plan rather than rolling it over into an IRA:
- In many cases you can borrow from the plan – an option that is not available with IRAs.
- You may be happy with the menu of funds that your former company chose.
- If you leave the company when you are at least 55 years old, you can begin to take money out without penalty.
If you keep the money with your former employer’s plan, it is easy to lose touch with what is happening at the company, and they could change investment options without you being immediately aware of the changes. It can also be hard to keep track of many different accounts, particularly if you’ve job-hopped over the years and have left behind accounts with each employer.
Transfer it to your new employer’s plan
In many circumstances you can transfer the proceeds from your former employer's plan directly into your new employer’s plan. It is important to check with your new company first to make sure that it will accept the transfer before you arrange for the rollover.
There are several upsides to this option:
- Your investments continue to grow income tax deferred.
- You avoid the tax penalty and federal income tax withholding.
- As with your old plan, you will probably be able to borrow against the account.
The downsides? Your investment choices will be limited to your new fund options, there may be new plan restrictions to consider, and you won’t have the investment and access benefits that an IRA offers.
Decisions concerning the money you have invested in your employer sponsored retirement account are indeed big ones. Before you choose, be sure to consider your overall financial circumstances, investment needs, and the tax consequence of each option.
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