Millennials have a reputation for changing jobs more frequently than past generations and in our current economic climate, they aren’t the only ones making changes. Now that two-thirds of American workers have access to a defined contribution retirement plan at work, it adds another layer of complexity to a job change. What should you do with the funds in your workplace retirement plan when you leave that employer? What options do you even have?
Retirement Plan Options When Changing Jobs
You usually have several options for what to do with your 401(k), 403(b), or other employer-sponsored retirement plan when you change jobs. In some cases, not all of these options are available, but often they are.
1. Leave Your Money In Your Old Plan
Your first option is to do nothing. Just leave your money where it is. Just because you have moved on to something different doesn’t mean that your retirement funds have to. Most of the time, at least. If your account balance is under $1,000, then your employer is allowed to automatically cash out your account when you leave. Also, many companies will automatically roll the account balance into an IRA if it is between $1,000 and $5,000.
The benefits of leaving your money where it is are that you don’t have to do anything and the funds are protected from creditors if you go through bankruptcy. Also, those who leave a job after turning 55 can take penalty-free withdrawals before age 59 ½ if they leave the funds with the same employer.
There are, however, some downsides to leaving retirement funds with a previous employer. First of all, you are limited to the investment options offered by the plan, which vary in price and quality. Without being actively employed by the company, you can no longer contribute to the plan or take a loan against your balance. You may also be limited in your withdrawal options once you need the money.
2. Roll The Money Into Your New Employer’s Plan
Another option is to roll your account balance into your new employer’s plan. For this to be possible, your new employer must first sponsor a retirement plan, and second, accept rollovers from other plans. Not all plans accept rollovers, so you will have to double-check with your plan administrator to see if this is a possibility.
This approach is nice because it keeps all of your money in the same place. Your money also continues to enjoy the benefits of being in a qualified retirement plan, such as tax deferral and creditor protection. Since you are actively employed by the plan sponsor, you can take loans from your account, if the plan allows it. It is important to remember, though, that any loans become due in full when you leave an employer.
3. Cash Out The Account
Many people simply cash out their retirement accounts when they leave a job. This is almost never advisable. When you withdraw funds from most retirement accounts before you reach age 59 ½, you are subject to a 10% early withdrawal penalty in addition to having to pay ordinary income taxes. Added on top of the high current cost of cashing out a retirement account is the opportunity cost. If you had left the money invested in a tax-advantaged account, how much would it have grown to by the time you retire? You are missing out on that as well.
4. Roll The Money Into An IRA
Your final option is to move your money from a workplace retirement plan into a personal retirement account, or IRA. In an IRA, you are the sole owner of the funds, unlike an employer-sponsored plan where the plan trustee actually owns the assets. Without having the account tied to an employer, any future job changes will have no effect on it.
IRAs also have more flexibility. With an IRA, you are not limited in your investment options and can shop around for lower fees or better performance. You can even invest in things besides stocks and bonds, like life insurance or real estate. IRAs also offer greater flexibility as to who you can name as a beneficiary or contingent beneficiary of the account. Finally, unlike workplace retirement plans, you can make penalty-free withdrawals for higher education expenses, medical expenses, or a home purchase under certain conditions.
One of the greatest benefits of an IRA is the simplicity that it offers. As long as you are working, you can continue to make contributions to the account, regardless of who your employer is or what benefits they offer. Having all of your retirement funds in one place makes it much easier to see how you are progressing towards your goals and manage your investment mix.
There are a lot of benefits to having your retirement funds in an IRA, as you can see. Usually, the option to transfer funds from a workplace retirement plan to an IRA is only available when you have left a job. However, there is one exception to that.
Once you reach age 59 ½, you can move money from your employer-sponsored retirement plan into an IRA even if you are still working. That is called an in-service distribution. In-service distributions are beneficial if you are still working and want the flexibility of having your money in an IRA or the opportunity to perform Roth conversions.
Another option you have if you move your money to an IRA is to convert it to a Roth. A traditional IRA account is funded with pre-tax money and income taxes are paid on all withdrawals. A Roth account is funded with after-tax money and all withdrawals are tax-free, even the earnings. To perform a conversion, you simply pay the appropriate income taxes on the funds and move them from a traditional IRA account to a Roth IRA account.
Roth conversions may save you money in taxes if you anticipate being in a higher tax bracket in the future. It is better to pay the taxes on the money at the present lower rate than in the future at a higher rate. Other benefits of having your money in a Roth account include not having to take required minimum distributions when you reach age 72. If you don’t anticipate needing the money to live on, having it in a Roth account allows you to leave it invested longer, potentially generating greater growth that you can leave for your family.
As you can see, there is no obvious right answer for what you should do with your retirement funds. There are advantages and disadvantages to every option and what is right for you depends on various factors. Here are several things to consider as you make your decision:
What investment options does your workplace plan offer?
If your employer’s plan only offers high-priced mutual funds, then you could probably do a lot better with your money in an IRA. However, if you have competitive options or lower-cost institutional pricing, then you may be better off over the long-term if you leave your money in your employer’s plan.
What needs do you have for the money?
You might want to move your funds to an IRA if you think you will want to access them for higher education or to purchase a home. If you want to be able to take a loan against them for other purposes, then it’s best to keep the money in your workplace retirement plan. In case you don’t anticipate needing to access the money even in retirement, then you should look into moving it into a Roth IRA so that you will not be subject to required minimum distributions.
How many different accounts do you have?
If you only have one old 401(k), then you might be fine just leaving it where it is. However, if you have 5 different accounts from 5 previous employers, it may be time to roll them all into one account to simplify things. The more your money is spread out, the harder it is to keep track of it and manage it well.
How We Can Help
Are you trying to figure out what to do with a workplace retirement account? We can help. As we have already laid out, you have several options and there are a number of things that you should take into consideration as you make your decision. Generally, it’s best to work with a professional if you want to be a wise steward as you navigate your choices.
At Guide Financial Planning, we can help you determine the best place for your retirement savings. We won’t automatically push you to move your money into an IRA for us to manage as some advisors do, because that may not be what is best for you. We offer several different services and types of engagements so that we can avoid those kinds of conflicts of interest. To learn more about how we can serve you, click to schedule a free call.
About Guide Financial Planning
Guide Financial Planning is led by founder Ben Wacek, who is a Christian fee-only Certified Financial Planner™ and Certified Kingdom Advisor®. He has a passion to help people of all income levels make wise financial decisions and steward their resources from an eternal perspective using Biblical principles. Based in Minneapolis, MN, he works with clients both locally and virtually throughout the country and abroad. You can follow the links to learn more about Guide Financial Planning and our team and the services we offer.