Laura reviews five options for managing your retirement account with an ex-employer.
Laura reviews five options for managing your retirement account with an ex-employer.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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If your workplace benefits include a retirement account, like a 401(k), 403(b), or 457 plan, you may wonder what happens to it if you leave your job. How you handle an old retirement plan is a critical decision that affects your financial future. This post will review your options and the retirement account rules so you can wisely handle a plan with an ex-employer.
Welcome back, everyone, and thanks for joining me. I'm Laura Adams, an author, financial spokesperson, speaker, founder of The Money Stack newsletter, and host of the Money Girl podcast with 43 million downloads.
If you're not already subscribed to the podcast, that's the best way to ensure you never miss an episode. There are now two weekly shows that come out on Wednesdays and Fridays. If you have a question you'd like me to cover, please leave it on our voicemail line at 302-364-0308. You can also send an email using my contact page at LauraDAdams.com.
What are workplace retirement plan benefits?
When you have a workplace retirement plan, like a 401(k), you own it, plus any vested balance contributed by your employer, and you can take it with you when you leave a job. It doesn't matter if you quit, got fired, or downsized; the same rules apply no matter why your employment ends.
You should always participate if offered a workplace plan because it comes with terrific tax benefits. For instance, with "traditional" retirement accounts, you defer taxes on contributions and investment growth until you take withdrawals in retirement. Contributions to Roth accounts are taxed upfront but allow you to avoid all tax on investment growth, giving you tax-free withdrawals in retirement.
So, if you qualify for a retirement plan at work and aren't participating, now's the time to enroll! Contribute as much as possible, even if it's just a tiny amount. Then, increase your contributions annually until you regularly invest 10% to 15% of your pre-tax gross income.
A common mistake is forgetting about a retirement plan with an old employer or thinking you can't continue enjoying its tax benefits once you leave a job with one. Nothing could be farther from the truth if you handle the account properly.
Once you're no longer employed by a company that offers your retirement plan, you have five options for managing it. But the fifth option I'll cover is the worst, so I never recommend it.
RELATED: Can you contribute to a 401(k) and an IRA in the same year?
1. Keep your retirement plan with an ex-employer.
Most retirement plans allow you to keep money in the account after you're no longer employed. However, you must maintain a minimum balance, such as more than $5,000.
If you don't have the minimum in the old account, the custodian typically can transfer your funds into an IRA or individual retirement account in your name. I'll cover more about IRAs in a moment.
Leaving money in an old retirement plan isn't the worst money move, but it gives you less flexibility than other options I'll cover. Your ex-employer could radically change the retirement plan without you knowing what's going on.
I only recommend leaving money in an old employer's retirement plan if it's a stable company, you love the investment choices, and it charges low fees. Be sure the plan doesn't charge higher fees once you're no longer an active employee.
The main pro for leaving retirement money in an ex-employer's plan is that it stays invested and grows. The downside is that you can't make new contributions because the plan's sponsor no longer employs you. However, you can still manage the account by selling or buying investments and allowing the existing balance to grow.
2. Rollover your retirement funds to a new or existing IRA.
Doing an IRA rollover is generally the best option for a retirement plan with an old employer–if you do it correctly! It's when you withdraw some or all of your balance in a retirement account and transfer it to another eligible retirement account. However, to avoid taxes and penalties, the accounts must be compatible, such as transferring a traditional 401(k) to a traditional IRA.
In other words, you can't roll over a pre-tax traditional 401(k) to an after-tax Roth IRA without paying taxes on the total amount. However, you can transfer a Roth 401(k) to a Roth IRA.
Some pros for rolling over a workplace plan to an IRA include:
The main con of doing an IRA rollover is that it may have fewer legal protections. Depending on your home state, assets in an IRA may have less legal protection from creditors than a workplace plan, which the federal Employee Retirement Income Security Act or ERISA covers.
Therefore, if you're having financial difficulties and are behind on bill payments or think bankruptcy could be in your future, get legal advice before making any decisions about your retirement funds.
The critical IRA rollover rule you must follow is to complete it within 60 days. If you miss the deadline and are younger than 59.5, the transaction would be an early withdrawal, subject to income tax, plus an additional 10% early withdrawal penalty. However, completing a rollover to a tax-compatible account within 60 days means you pay no taxes or penalties.
If you need to open a new traditional or Roth IRA, checkout an online investing platform like Betterment or Empower. They can even do a direct rollover where funds get automatically transferred into your new account without you having to handle them.
READ ALSO: Is it better to have a traditional or Roth IRA?
3. Rollover your retirement funds to a new workplace plan.
Most 401(k)s and 403(b)s allow a rollover from your old employer's plan once you're eligible to participate in the new plan. So, check with your benefits administrator about what's possible. And just like an IRA rollover, you must complete a workplace plan transfer within 60 days to avoid income tax and a penalty.
Here are some pros for doing a workplace-to-workplace rollover:
Some cons for moving money from one workplace plan to another include:
4. Rollover your retirement funds to a self-employed plan.
If you have self-employment income from a part- or full-time side gig or business, you can move funds into a retirement plan for the self-employed, such as a solo 401(k) or SEP-IRA.
A benefit is that they allow higher annual contribution limits than an IRA. However, a downside of transferring funds to a self-employed plan is that it may offer fewer legal protections than a workplace plan, depending on laws in your home state.
You’ll find many investing platforms that offer small business retirement plans, like Betterment and Empower. Your options depend on whether you have employees or plan to have them in your business.
LISTEN ALSO: 10 rules for successful investing you should know
5. Cash out your retirement funds.
Cashing out a retirement plan after leaving a job is the easiest but worst option. As I mentioned, if you're younger than 59.5, cashing out would be an early withdrawal, subject to income tax plus an additional 10% penalty.
Let's say your 401(k) vested balance is $100,000, and your average tax rate is 25%. After you account for the additional 10% early withdrawal penalty, you'd lose 35% of your retirement funds, leaving you with just $65,000. So, I never recommend cashing out a retirement account early because it's too expensive.
Also, note that if your retirement account has a low balance, such as $1,000 or less, the plan custodian may automatically cash it out for you. If so, they must withhold 20% for taxes, although you may owe less or more to the government.
The plan custodian must file Form 1099-R to document the retirement distribution and pay you the balance. Then, you settle any difference in taxes you owe or should get refunded on your next tax return.
To sum up, the best place for retirement money with an old employer depends on the quality of your old plan and the flexibility and legal protections you want. Your goal should be to keep your retirement money where it can grow using low-cost, diversified investment options.
Contact your old retirement plan's custodian if you have questions about rollovers. They can walk you through the process, ensure you follow the rules, and help you avoid paying taxes and penalties on your retirement funds.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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