Choices for Your 401(k) Retirement Plan When You Leave or Change Your Job Including an IRA Rollover

For those who have money stashed away in an employer sponsored 401(k) retirement account, there are a number of options they can take with those funds when they move on from their current place of employment. However, before initiating any of these choices, it’s important to understand the pros and cons of each because what may seem beneficial to you at first glance may actually come back to haunt you at tax time – so beware of the effects on both a long and short term basis.

Cash Out

One of the first choices that may pop into your head is to take the money and run. While this may seem to provide the immediate benefit of paying off current bills or providing funds for day to day living expenses, this option in particular tends to have the most dire consequences when it comes to your financial well being over time.

One reason for this is that you will be liable for a 10% early withdrawal penalty if you cash the funds out prior to attaining age 59 ½. In addition, you will also be taxed on the amount that you withdraw. So, if you plan to cash out a large lump sum, you can plan on also handing over at least 20 percent in taxes and penalties to Uncle Sam.

By cashing out your entire 401(k) you also put yourself in the position of losing future earning power on those funds. In other words, any potential future gain on that money will be forever lost if those dollars are no longer there to earn on.

Leave your Savings in the 401k Retirement Plan sponsored by your Former Employer

This may be a good choice if you like the investment options available through your (soon to be ex) employers plan, or you are undecided about which option is right for you and need more time to decide. But keep in mind that if you leave your funds in your past employer plans you cannot contribute additional funds, may be saddled with limited investment choices and may be subject to higher administration fees. Tied to this is that fact that your former employer could decide to make changes to the plan that you have no control over, also affecting your account.

So use this option as a temporary option and instead look to pick one of the following two options as a better long term choice for your retirement savings.

Move the Funds to Your Future Employer

Another viable option for your 401(k) account is to move it to your future employer, if applicable. In many cases this will allow you to continue saving on a tax deferred basis while getting some of the cost subsidies employer sponsored plans provide to active employees. This will also allow you to begin participating in your new employer’s retirement plan (and matching program) with an already established lump sum.

Although this option may be wise for some, there are a few drawbacks. One such issue is that by keeping the funds tied in to an employer’s plan, you could have limited options in which to invest your money. In addition, there could also be limitations associated with the new employer’s plan such as who you may choose as a beneficiary for your account.

I experienced this issue when I moved employers and had to shift from a Fidelity 401K based plan to one that had much fewer options and higher fees. While the move between 401K plans was very straight forward, make sure you look at the investment options you have and what (additional) fees you may have to pay.

Roll Your Funds Into A Self Managed Rollover IRA Plan

When leaving an employer, many people choose to rollover their 401(k) funds into an IRA, or Individual Retirement Account. A rollover simply means moving your retirement savings from your employers plan to a self managed plan. An IRA rollover will allow you to not only continue saving on a tax deferred basis, but it also comes with a very wide variety of investment choices for you.

By investing in an IRA account, you may choose to invest your funds into stocks, bonds, mutual funds, or a number of other vehicles, thus allowing you more diversification and a better allocation of your assets. You can open up a Rollover IRA at most leading financial and brokerage institutions.

If you have an employer sponsored plan through one of the major retirement account administrators like Vanguard or Fidelity, the process to rollover to an individual IRA is actually very easy. I recently had to do this rollover for my wife after she lost her job and the whole process took less than 10 minutes and she was able to keep the same diversified portfolio of funds in her self managed IRA as was available in her employer’s 401K plan.

One thing to keep in mind when choosing this option, however, is that you may need to work with an investment advisor who is well versed in retirement planning and who can help you to make the best choices for your retirement funds.

Another point to remember is that if you move your 401K plan or change employers you will need to pay back and 401K loans you may have taken.

In Summary

When you are switching or in between jobs, rolling over your funds to an IRA is probably the best option because it allows you keep control and in many instances broaden the investment choices for your retirement assets relative to those in a standard 401k plan. The worst choice, unless you are over 60 or in severe financial hardship, is to take the cash-out option which will result in penalties and larger tax bill.

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