By: Johnathan R. Rankin CRPC® CEPA®
Changing jobs can be stressful on its own. Whether you’re making a career change or just got laid off, your 401(k) may be at the bottom of your to-do list. When leaving an employer, there are plenty of options for what to do with your vested retirement funds.
If you leave your job (voluntarily or involuntarily), you’ll be entitled to a distribution of your vested balance. Your vested balance always includes your own contributions (pre-tax, after-tax, and Roth) and typically any investment earnings on those amounts. It also includes employer contributions (and earnings) that have satisfied your plan’s vesting schedule. In general, you must be 100% vested in your employer’s contributions after 3 years of service (“cliff vesting”), or you must vest gradually, 20% per year until you’re fully vested after 6 years (“graded vesting”). Plans can have faster vesting schedules, and some even have 100% immediate vesting. You’ll also be 100% vested once you’ve reached your plan’s normal retirement age. It’s important for you to understand how your particular plan’s vesting schedule works, because you’ll forfeit any employer contributions that haven’t vested by the time you leave your job. Your summary plan description (SPD) will spell out how the vesting schedule for your particular plan works. If you don’t have one, ask your plan administrator for it. If you’re on the cusp of vesting, it may make sense to wait a bit before leaving, if you have that luxury.
Cash it out
While this pool of dollars may look attractive, don’t spend it unless you absolutely need to. If you take a distribution you’ll be taxed, at ordinary income tax rates, on the entire value of your account except for any after-tax or Roth 401(k) contributions you’ve made. And, if you’re not yet age 55, an additional 10% penalty may apply to the taxable portion of your payout. In normal circumstances, cashing in on your retirement account before age 59 1/2 will subject you an early withdrawal penalty. But the CARES Act, passed by Congress in March, has relaxed early distribution penalties. For 2020, you can take out up to $100,000 without incurring the usual 10% tax penalty that’s assessed on withdrawals made before the age of 59 1/2. And, in some specific circumstances — including if you become disabled or need to pay medical bills — you might qualify for a hardship exemption.
Note that this limit applies to an individual — not a particular account. If you have multiple retirement accounts, you’re still limited to a total withdrawal of $100,000. And if you repay whatever you withdraw within three years, you don’t have to pay taxes on it.
up with the 20% that’s been withheld until you recapture that amount when you file your income tax return.
Keep it where it is
If your vested balance is more than $5,000, you can leave your money in your employer’s plan at least until you reach the plan’s normal retirement age (typically age 65). The upside to keeping the 401(k) where it is, there is no action required aside from updating your contact information. It is the path of least resistance.
Roll over to a new employer’s 401(k) plan or to an IRA
Your employer must also allow you to make a direct rollover to an IRA or to another employer’s 401(k) plan. As the name suggests, in a direct rollover the money passes directly from your 401(k)-plan account to the IRA or other plan. This is preferable to a “60-day rollover,” where you get the check and then roll the money over yourself, because your employer has to withhold 20% of the taxable portion of a 60-day rollover. You can still roll over the entire amount of your distribution, but you’ll need to come up with the 20% that’s been withheld until you recapture that amount when you file your income tax return.
Assuming both options are available to you, there’s no right or wrong answer to this question. There are strong arguments to be made on both sides. You need to weigh all of the factors, and make a decision based on your own needs and priorities. It’s best to have a professional assist you with this, since the decision you make may have significant consequences — both now and in the future.
Reasons to consider rolling over to an IRA:
• You generally have more investment choices with an IRA than with an employer’s 401(k) plan. You typically may freely move your money around to the various investments offered by your IRA trustee, and you may divide up your balance among as many of those investments as you want. By contrast, employer-sponsored plans generally offer a limited menu of investments (usually mutual funds) from which to choose.
• You can freely allocate your IRA dollars among different IRA trustees/custodians. There’s no limit on how many direct, trustee-to-trustee IRA transfers you can do in a year. This gives you flexibility to change trustees often if you are dissatisfied with investment performance or customer service. It can also allow you to have IRA accounts with more than one institution for added diversification. With an employer’s plan, you can’t move the funds to a different trustee unless you leave your job and roll over the funds.
• An IRA may give you more flexibility with distributions. Your distribution options in a 401(k) plan depend on the terms of that particular plan, and your options may be limited. However, with an IRA, the timing and amount of distributions is generally at your discretion (until you reach age 72 and must start taking required minimum distributions in the case of a traditional IRA).
• You can roll over (essentially “convert”) your 401(k) plan distribution to a Roth IRA. You’ll generally have to pay taxes on the amount you roll over (minus any after-tax contributions you’ve made), but any qualified distributions from the Roth IRA in the future will be tax free.
Reasons to consider rolling over to your new employer’s 401(k) plan
• Many employer-sponsored plans have loan provisions. If you roll over your retirement funds to a new employer’s plan that permits loans, you may be able to borrow up to 50% of the amount you roll over if you need the money. You can’t borrow from an IRA — you can only access the money in an IRA by taking a distribution, which may be subject to income tax and penalties. (You can give yourself a short-term loan from an IRA by taking a distribution, and then rolling the dollars back to an IRA within 60 days; however, this move is permitted only once in any 12-month time period.)
• You may be able to postpone required minimum distributions. For traditional IRAs, these distributions must begin by April 1 following the year you reach age 72. However, if you work past age 72 and are still participating in your employer’s 401(k) plan, you can delay your first distribution from that plan until April 1 following the year of your retirement. (You also must own no more than 5% of the company.)
In general, if you have an outstanding plan loan, you’ll need to pay it back, or the outstanding balance will be taxed as if it had been distributed to you in cash. If you can’t pay the loan back before you leave, you’ll still have 60 days to roll over the amount that’s been treated as a distribution to your IRA. Of course, you’ll need to come up with the dollars from other sources. 1 If you reached age 70½ in 2019, you will need to begin taking RMDs by April 1, 2020, unless you are still working for the company sponsoring the plan.
If you are trying to figure out where to start, let one of our advisors help. We believe that it is important for every investor to have access to detailed financial planning. That is why right now we are providing comprehensive planning at no cost. We will run through a detailed analysis of your complete financial picture while running your portfolio through a number of stress tests to make sure that you are positioned properly. Please use the link below to get started on your analysis today.
Our firm can help you make informed decisions as you are in the process of transition. We can help by reviewing your previous employer’s plan and weighing the benefits of your new employer’s retirement plans. More importantly, our involvement will make sure the necessary steps are taken to move your funds with limited repercussions.
Changing jobs under any circumstance can be stressful enough. Trying to make the best financial decisions for your long-term goals during an emotional and stressful period may be very touch. In addition to our comprehensive financial planning, we have put together a Job Transition Guide which includes a checklist and income planning worksheet to help keep everything organized. Click below to access our Job Transition Guide
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