About the author: Lamar Watson, CFP®, is a Fee-Only Financial Advisor in the Washington, D.C. area, that works with clients virtually across the country. Lamar's work with his clients focuses on budgeting, employee benefits, paying down debt, buying their first home, and investing. Lamar is the Founder of Dream Financial Planning, a virtual financial planning firm specifically designed to help young professionals and minorities take control of their finances and fulfill their dreams. Feel free to schedule a complimentary consultation to learn how we use the The DREAM Financial Planning Process ™ to help our clients achieve their goals.
If you've recently changed jobs, your 401(k) may be at the bottom of your to-do list. However, moving your 401(k) is an incredibly important step that must be well thought out. When leaving an employer, there are typically three workable opportunities to make sure you're on track for retirement. Your options need to be carefully evaluated to make sure that your actions are aligned with your goals.
The first step is to read through your plan's agreement. Doing so will help you understand if your employer plan accepts rollovers, as some may not. Ultimately, plan sponsors maintain the membership guidelines. In some cases, your former employer's plan may allow the sponsor to cash out the account when you end employment. Withdrawals could trigger income taxes and a 10 percent penalty.1
Before you start, gather any appropriate account statements and contacts. When you signed up for the plan, you may have selected both a traditional 401(k) and a Roth 401(k), but keep in mind, these are two separate accounts. Traditional 401(k) contributions are not taxed but are subject to penalties in the case of early withdrawal. Roth contributions, on the other hand, are taxed, but withdrawals have no adverse effect as long as the distribution is considered qualified by the IRS.2
It's a good idea to meet with a Financial Advisor before starting the process. You'll want to choose the right type of retirement account and avoid paying taxes or penalties for potentially selecting a plan that isn't right for you. For example, if you decide to roll your 401(k) into a Roth, you should prepare to pay taxes on the full amount.
The right Financial Advisor can help you make informed decisions as you continue saving, and they should be able to provide additional guidance on broader financial planning topics as well. They can offer assistance by reviewing your previous employer's plan and weighing the benefits of your new employer's retirement plans. More importantly, their involvement will make sure the necessary steps are taken to move your funds with limited repercussions.
Don't leave your old 401(k) behind
When investing in an employer-sponsored 401(k), your investment options are limited to those your employer selects for you. Your 401(k) plan isn't managing your investments for free. Most people don't realize that the underlying investments in 401(k) plans often come with significant expenses and typically only cover investment management. Opening a Rollover IRA could potentially lower your fees and offer you a wider variety of investment options.
In addition, a Financial Advisor should be able to help you figure out how much you need to retire and work with you to put a plan in place to make sure you get there. If you're working with our firm, in addition to managing your investments, we'll utilize The DREAM Financial Planning Process ™ as a value-added service. Whether you need help with budgeting, managing student loan debt, or buying your first home, this process is tailored to the unique needs and goals of those in their 30s and 40s.
However, If you decide to leave money in your previous employer's plan, it's a good idea to have an advisor review the plan's progress over time. With this in mind, it may be time to shift or increase the associated contributions. If you decide to transfer funds, the previous plan's administrator can often send the check to a designated contact. Working with your advisor will be beneficial as they can coordinate such transactions.
Don't cash out your 401(k)
I only recommend withdrawing funds from a 401(k) or other retirement accounts if you're facing an emergency situation. This is especially true if you're considering cashing out a 401k after a job change. Withdrawing $10,000 can have a significant negative impact on your retirement and ultimately cost you in excess of $200,000 over 30 years, based on historical returns.
The young professionals in their 30s that I work with are often trying to balance starting a family, student loans, saving for retirement, and purchasing their first home. Should I take money out of my 401(k) to pay down debt is the #1 question I get from both prospective and current clients. If you'd like help balancing your financial priorities, feel free to schedule a complimentary consultation.
What to do with an old 401(k)
Age is another contributing factor when deciding how to approach a former employer's contributions. For instance, if you switch jobs and turn 55 in the same year, you may withdraw funds from the 401(k) without penalty. Rolling the funds into another 401(k) or IRA imposes a higher age limit of 59½ years to avoid withdrawal penalties, depending on the plan.3 Talking with a financial advisor is the best advice when making such financial decisions in order to avoid costly mistakes.
Depending on the length of your previous employment, it's also a good idea to check the associated vesting schedules. Vesting schedules are tied to the employer's contributions and determine the amount and date when the employer's contributions are legally yours. Your own contributions are fully vested from day one.
It's essential to keep in mind that your new employer may have a waiting period before you're able to rollover funds. In this case, your advisor may suggest that you open an investment account to continue contributions during the waiting period. Opening another account allows you to take advantage of the tax deduction until you make your final decision. Keeping investment growth active could be more beneficial for you in the long run.
If you'd like guidance evaluating the best options for your 401(k) after a job change, feel free to contact me. I'd be happy to complete a complimentary analysis of the fees your paying to manage any old 401(k) plans.
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