Often touted as a defining characteristic of the Millennial Generation, Americans these days are bouncing from job to job at an alarming rate. In 2012, the Bureau of Labor Statistics says the typical US worker stayed on the job for 4.6 years. A report that same year put out by the US Labor Department notes that the average worker holds 11 jobs from age 18 to 46. With the rising popularity of 401(k) plans in lieu of traditional pension plans, many workers have gathered up quite a collection of 401(k) accounts as they move from job to job.
What Are Your 401(k) Plan Options?
Many people aren’t sure what to do with their 401(k) plans when they leave a company or what they are even allowed to do. When it comes to company-sponsored 401(k) retirement plans, there are four different options available to you when you leave an employer:
1. Leave the plan with your previous employer.
This is the easiest option because it doesn’t require you to actually do anything. However, it might not even be an option for everyone. If your account holds less than $1,000, your employer is allowed to automatically cash out your account when you leave. If your account holds between $1,000 and $5,000, most employers will automatically roll your account into an IRA for you when you leave. Most people need to have over $5,000 in their account to even have the option of leaving it where it is.
There are a few benefits to leaving your money with your previous employer. If you turned 55 before leaving the job, then you can take penalty-free withdrawals before turning 59 ½, which isn’t an option otherwise. With the company plan you may have lower priced or unique investment options that will no longer be available to you if you move the money. Also, because of federal law, your money is safer from creditors in a 401(k) plan than in an IRA if you go through a bankruptcy.
There are some downsides to leaving your money behind when you move on, though. You won’t be able to contribute to your plan anymore or take a loan from it. You are limited to the investment options the company offers, which may have higher fees or lower returns than you can find elsewhere. You are also limited in your withdrawal options. Instead of taking a partial withdrawal you may be forced to take the whole amount. If you like having your money in a 401(k), but don’t like your old company’s plan, there is another option.
2. Move your 401(k) money into your new employer’s plan.
Not all employers accept rollovers from other plans, so you will have to consult your new plan administrator to see if this is even an option for you. People often choose this approach as a way to consolidate assets into one account instead of having multiple small retirement accounts lying around.
Most of the advantages of moving your money into your new employer’s plan are the same as for keeping it in the old one, such as creditor protection, possible lower-cost investment options, and unique, plan-specific investment options (which vary by plan). Also, if the plan allows, you are able to take a loan against your account, though it is important to remember that it is due in full when you leave that job. The disadvantages to this approach are also the same as the previous option; you are limited in your investment options and subject to the plan rules, which may have certain transaction limits.
3. Cash out the account.
Though a 2012 report by Transamerica Center for Retirement Studies said that 25% of unemployed or underemployed workers chose this route, it is almost never a good idea. Withdrawing the funds from your 401(k) account before you are 59 ½ obligates you to pay ordinary income taxes on it and a 10% early withdrawal penalty. For someone in a the 25% federal income tax bracket paying 7% state income taxes, a $50,000 cash out would cost them $21,000 in penalties and taxes.
That is essentially forfeiting 42% of your money just so you can have it now instead of later. And that doesn’t even factor in all of the growth and interest it would have earned if it had been left in the account until retirement. The only exception is for people who are 55 or older when they leave their job; they still have to pay income taxes on the money but the penalty is waived. If you find yourself desperate for money, even a loan with 30% interest would be cheaper than cashing out your 401(k) account (if you’re not 55 yet), and if you do withdraw money, it is foolish to take any more than you really need.
4. Rollover your 401(k) into an IRA.
When considering what to do with their old 401(k) accounts, many people choose to roll them over into IRAs, or Individual Retirement Accounts. These accounts differ from 401(k)s in a variety of ways. First of all, when you are an IRA account holder you are the complete owner, whereas, with a 401(k) account, the plan trustee actually owns the assets. Also, unlike your 401(k), your IRA is not tied to a specific employer, so changing jobs has no effect on it. But you don’t have as much protection from creditors with an IRA as you do under a 401(k) plan, either.
There are many advantages to having your money in an IRA as opposed to a 401(k) plan. You have much more flexibility with the IRA. You can shop around for low fees and solid investment options. Instead of being tied to the 20 or so options your company offers, you can invest your IRA in just about anything except life insurance or collectibles. You can even invest your IRA in real estate that you manage through a self-directed IRA. IRAs usually offer much greater flexibility as to who you can name as a beneficiary or contingent beneficiary of the account.
When you roll all of your old 401(k) accounts into an IRA you are able to keep adding money to the account, no matter who your employer is in the future. With all of your money in one place, it’s much easier to see the big picture of where you stand financially and manage your asset mix. The IRS even allows you to withdraw earnings penalty-free from your IRA before you turn 59 ½, as long as your account has been open for five years and the money is used for qualified expenses, such as buying your first home or higher education or medical expenses.
You also have the option to convert to a Roth IRA, which could save you immensely on taxes in the long run and has even more permissive withdrawal rules and no required minimum distributions.
As always, it is a good idea to consult with an experienced financial professional when making changes to your retirement savings plan. A qualified professional can help you understand your options and how they relate to your specific situation, as well as walk you step-by-step through the process. If you have an old 401(k) account sitting around, give us a call at 909-981-1720 and we will help you decide the best way to build it into the retirement that you dream of.
Philip A. Board MSFS, CFS, is a retirement planning specialist and the founder of 1 on 1 Financial, an independent comprehensive investment firm serving individuals and businesses near Upland, California. Through educational workshops and a non-sales environment, 1 on 1 Financial specializes in working with employees of Southern California Edison, UPS, Esri and Verizon.