Congratulations on your new job! What will you do with your 401(k)?
By John Brandon
One of the common threads of a transitioning workforce is that many individuals who leave their jobs are faced with a decision about what to do with their 401(k) account held with their former employer. According to the most recent annual Form 5500 data (kind of like a 401(k) tax return), there are an estimated 635,000 defined contribution plans (where an employee contributes, a pension plan is a defined benefit plan) in the United States, covering an estimated 86.6 million participants with account balances totaling $9.3 trillion in assets. As of May 2023, it is estimated that there are 29.2 million forgotten 401(k) accounts worth approximately $1.65 trillion. That accounts for roughly 25% of all 401(k) assets and is equivalent to about 6% of US GDP! My advice is to not become part of these statistics. Let’s explore four of your options.
- Leave It with Your Previous Employer
You may do nothing and leave your account in your previous employer’s 401(k) plan. However, if your account balance is under a certain amount, typically $7,000, your ex-employer may elect to distribute the funds to you. This may count as a premature distribution subject to penalties and income tax.
There may be reasons to keep your 401(k) with your previous employer — such as investments that are low-cost or have limited availability outside of the plan. Other reasons are to maintain certain creditor protections that are unique to qualified retirement plans or to take withdrawals prior to turning 59 ½ years old. Some plans allow for withdrawals at age 55 without penalty.
The primary downside is that individuals can become disconnected from the old account and pay less attention to the ongoing management of its investments. This is where you could end up as one of the previously referenced statistics.
- Transfer to Your New Employer’s 401(k) Plan
Provided your current employer’s 401(k) accepts the transfer of assets from a pre-existing 401(k), you may want to consider moving these assets to your new plan.
The primary benefits to transferring are the convenience of consolidating your assets, retaining their strong creditor protections, and keeping them accessible via the plan’s loan feature, if offered. If the new plan has a competitive investment menu, many individuals prefer transferring their account and making a clean break from their former employer.
The Department of Labor has proposed automatic portability transactions. This could help workers keep track of their 401(k)s and aid in the transfer process. If you think you’ve left benefits at a previous employer, you can check the National Registry of Unclaimed Retirement Benefits (www.unclaimedretirementbenefits.com).
- Roll Over Assets to a Traditional IRA or Roth IRA
Another choice is to roll assets over into a new or existing traditional or Roth IRA. It’s possible that an IRA may provide some investment choices that may not exist in your new 401(k) plan. The drawback to this approach may be less creditor protection and you will have to wait until age 59 ½ to access the money without penalty.
Remember, don’t feel rushed into making a decision. You have time to consider your choices and may want to seek professional guidance to answer any questions. However, if you start the rollover process you have 60 days to deposit the funds in the new account. Otherwise, the IRS will consider it a withdrawal and it may be taxable.
- Cash out the account
The last choice is to cash out of the account. However, if you choose to cash out, you may be required to pay ordinary income tax on the balance plus a 10% early withdrawal penalty if you are under 59½ years old. In addition, employers may hold onto 20% of your account balance to prepay the taxes you’ll owe.
Think carefully before deciding to cash out a retirement plan. Aside from the costs of the early withdrawal penalty, there’s an additional opportunity cost in taking money out of an account that could potentially grow on a tax-deferred basis. For example, taking $10,000 out of a 401(k) instead of rolling over into an account earning an average of 8% annually in tax-deferred earnings could reduce your savings by $100,000 after 30 years.
Another consideration is a strategy called Roth conversion. Some 401(k) plans allow for in-plan Roth conversions in which traditional contributions or employer match dollars are converted to Roth. Check with your former and new employer plan if this feature is available. The benefit here is a Roth contribution will not be subject to required minimum distributions, or taxable when withdrawn. However, converting traditional contributions or matching dollars to Roth may trigger a taxable event so consult a financial advisor and accountant first. Before you submit the paperwork to transfer the account, ask questions, know the details, and please keep up with where your money resides. Should you have any questions or concerns about your 401(k), the BCS Wealth Management team is happy to help.