When you leave your job – be it by retiring, resigning or via a lay-off/termination – you generally have several options for what you can do with your 401(k) account.
Depending on your account balance, you may be able to keep it with your old employer’s plan. If you’re changing employers, rather than retiring, you may be able to “roll over” the account to your new employer’s 401(k) plan. You also have the option to roll over the old 401(k) into an Individual Retirement Account, or IRA. Depending on your age, you may also begin taking distributions from the account. Finally, you can simply cash out the account balance.
Let’s look at each of these options in a bit more detail.
Leave Your Account with Your Old Employer
If your account balance is over $5,000, most plans will allow you to leave it where it as after you separate from service. If your account balance is less than $1,000, your old employer can force you out of the plan by issuing you a check. If your account balance is between $1,000 and $5,000, your old employer must help you set up an IRA so that you can roll over your funds in a tax-deferred manner.
If you’ve accumulated a substantial amount in your account, it may make sense to leave your 401(k) with your old employer. One reason for doing so might be that the old plan offers a great investment menu, with highly-rated, low-cost investment options, and low fees and expenses. Another reason might be that you lack the affinity, aptitude or time to manage the account on your own via an IRA.
By definition, though, 401(k) plans will have investment menus with a limited range of choices, and so a roll over to an IRA – in which the range of investment options is effectively unlimited – should always be given serious consideration.
Roll Your Account Over to Your New Employer’s Plan
If you’ve changed employers, you should evaluate your new company’s plan to see if a roll over into the new plan makes sense. If it does, once you’re enrolled in the plan you can elect to have the administrator of your old employer’s plan transfer your account balance over. If the old plan’s administrator instead issues you a check for your account balance, you must deposit the funds into your new 401(k) within 60 days to avoid having the payment be considered taxable income.
Roll Over Into an IRA
If you retire, or move to an employer that does not offer a suitably attractive retirement plan, but you don’t want to leave your 401(k) with your old employer, you can choose to roll the account balance over into an IRA.
The rollover process is basically the same as for a transfer into a new 401(k) plan, in that you can either have the plan administrator do it directly, or take a full distribution by check and deposit it into your IRA within 60 days.
As we noted above, rolling over your old 401(k) into an IRA may be your best option, unless the investment options offered by your old plan are extremely attractive.
It should be noted that traditional IRAs require minimum distributions (so-called “RMD’s”) beginning when you reach age 70 1/2, regardless of whether or not you’re still working.
Generally speaking, the biggest advantage of rolling an old retirement plan account into an IRA is the flexibility you gain to invest in (virtually) anything you want, without the constraints imposed by a 401(k) plan investment menu. Of course, if you lack the affinity, aptitude or time to manage the IRA account, you should consider hiring an experienced, independent investment advisor to help.
Begin Taking Distributions
Once you reach age 59 1/2, you can begin taking distributions from a 401(k) (or traditional IRA). If you left your employer due to retirement, it may make sense to begin drawing on your account balance for income. These distributions will be taxed as ordinary income.
If you retire before age 55 or switch jobs before age 59 1/2, you may still take distributions from your 401(k). However, you will be required to pay a 10% penalty, in addition to income tax, on the taxable portion of your distribution, which may be all of it. Note that the 10% penalty does not apply to those who retire after age 55, but before age 59 1/2.
Cash Out Your Account
You also have the option of simply cashing out your old plan account balance by taking a “lump sum distribution”. We would strongly caution against doing so, however. A full distribution not only reduces your tax-deferred retirement savings, you’ll have to include the amount of the distribution in your yearly taxable income. Depending on the size of the distribution, this may bump you into a higher tax bracket. In addition, if you’re younger than age 59 1/2, you will have to pay an additional 10% penalty on the distribution, with very few exceptions.
As you can see, the decision you make can have significant tax consequences. If you’ve left an employer, still have a retirement plan account with them, and are unsure what to do, or if you have other questions about investing and getting ready for retirement, feel free to call or send us an email. We’d love to help.
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