Not sure what to do with an old retirement plan from a previous job?
Not sure what to do with an old retirement plan from a previous job? Laura answers a listener's question and reviews five options for managing your retirement account.
Can't remember where your old 401(k)s are? Use these 3 tips to locate them.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Hello, friends, and thanks for joining me this week! My name is Laura Adams, and I’m a personal finance expert and author who’s been hosting the Money Girl Podcast since 2008. My most recent title is Money-Smart Solopreneur–A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers. It was a No. 1 Amazon New Release and here are a couple of verified reviews for the book:
Bill says, “A must-have reference guide for any freelancer or self-employed person! Money-Smart Solopreneur stays on my desk as a reference guide, helping me quickly understand many of the sometimes intimidating aspects of owning a business. Instead of trudging for hours through the internet, Laura's deep knowledge and practical approach make it easy to understand even the most daunting subjects within minutes. Solopreneur has boosted my confidence in owning my own business and has allowed me more time to do what I do best.”
And Halie says, “Seriously life-changing for my business! I’m not completely finished with the book, but it’s already provided me with so much value and significantly lessened my anxiety and stress when it comes to facing money management in my business. With so many videos, blogs, courses, etc out there, I feel like this book cuts through it all and gives you the essentials and lesser-known tips that tend to get lost in a lot of other resources. There are some productivity tips in there as well that I’ve since adopted and use on a daily basis! I couldn’t recommend this book enough. Well done.”
If Bill or Halie are listening, thanks so much! If you’re also considering self-employment or currently building a solo or small business, grab a copy of Money-Smart Solopreneur as a paperback, ebook, or audiobook!
Here on Money Girl, my mission is to help you get the knowledge and motivation to prioritize your finances, build wealth, and have more security and less stress.
If you’re enjoying the show or have personal finance or small business questions, leave a message 24/7 on our voicemail line at 302-364-0308. Or, I’d love you to shoot me an email using my contact page at LauraDAdams.com.
Today's episode is number 732, called What Should You Do With an Old Retirement Plan?
I want to thank Michael B. who inspired the show. He says, “Hi, Laura, I’m a long-time listener of the podcast! I recently changed jobs and am seeking advice on what to do with my 401(k). I can’t participate in my new employer’s plan until after a year of service. What are my options for managing the funds in my account with my previous employer and the pros and cons of each?”
Thank you, Michael! I know many people are in similar work transitions and unsure what to do with their retirement money. And even if you’re not changing jobs any time soon, don’t miss this show. It’s critical to get familiar with retirement account rules so you know how to handle it wisely if you leave an employer–so stay with me!
Fortunately, when you have a workplace retirement plan, such as a 401(k) or 403(b), you can take your vested balance with you when you leave your job. It doesn't matter if you quit, got fired, or downsized, the same rules apply no matter why your employment ends.
First, I want to briefly review why you should use a retirement account in the first place. Investing money using one or more retirement accounts is smart because they come with terrific tax advantages.
With “traditional” retirement accounts, you’re allowed to defer taxes on contributions and investment growth until you take withdrawals in retirement. And “Roth” account contributions are taxed upfront but allow you to avoid all tax on your investment growth, giving you tax-free withdrawals in retirement, which could add up to massive tax savings.
The bottom line is that investing under the umbrella of a tax-advantaged retirement account helps you accumulate a bigger balance than with a taxable brokerage account.
So, if you have a retirement plan at work and aren't participating, now's the time to enroll! Contribute as much as you can, even if it's just a small amount. Make a goal to increase your contributions annually until you're regularly investing at least 10% to 15% of your pre-tax, gross income.
A common mistake I see employees make is thinking that once they leave a job with a retirement plan that they can't continue enjoying the account’s tax benefits. Nothing could be farther from the truth if you handle the account properly.
Also, many people forget about old retirement plans until many years later. Use these tips to find your old 401(k) if you suddenly remember that you contributed money to an ex-employer’s retirement account.
Once you're no longer employed by a company that sponsors your retirement plan, you have five options for managing your money. Let’s cover them now.
Cashing out a retirement plan after leaving a job is the easiest but absolute worst option. Why? Well, because if you’re younger than age 59.5, it’s considered an early withdrawal, requiring you to pay income tax plus a 10% penalty.
For instance, let's say your 401(k) has a $100,000 vested balance and your average tax rate is 30%. After you account for the additional 10% penalty, you lose 40% of your retirement funds, leaving you with $60,000. That’s a terrible loss! So, my recommendation is to never cash out a retirement account.
Also, note that if your retirement account has a low balance, such as $1,000 or less, the plan custodian may automatically cash you out. 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.
The only pro for cashing out an old retirement plan is convenience, I guess. But it certainly comes at a massive cost. As I mentioned, the huge downside is paying a hefty income tax and penalty, leaving you with much less for retirement.
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, but you have more than the cash-out threshold, the custodian typically has the authority to transfer your funds into an IRA, or individual retirement account, in your name.
Leaving money in an old retirement plan is certainly better than cashing it out. But it doesn't give you as much flexibility as other options I’ll cover here. The company could radically change the plan or even go out of business 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. Just make sure the plan doesn't charge higher fees once you're no longer an active employee.
Another reason you might want to leave retirement money in an old employer's plan is if you're unemployed or have a job that doesn't offer a retirement account. Or, maybe you’re like Michael and haven’t qualified yet to enroll in a retirement plan at your new job.
The main pro for leaving retirement money in an ex-employer’s plan is that it stays invested and growing. The downside is that you can't make new contributions because you're no longer employed by the plan’s sponsor. However, you can still manage the account as you wish by selling or buying investments and simply allowing the existing balance to grow.
The IRS allows you to withdraw some or all of your balance in one retirement account and transfer it to another eligible retirement account, which is called a rollover. 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 full amount. However, you can transfer a Roth 401(k) to a Roth IRA.
Here are some pros for rolling over a workplace plan to an IRA:
Some cons for doing an IRA rollover include:
The main rollover rule you must follow is completing it within 60 days. If you miss the deadline and are younger than age 59.5, the transaction would be an early withdrawal, subject to income tax, plus the additional 10% penalty that I mentioned. But completing a rollover to a tax-compatible account within the 60-day window means you pay no taxes or penalties.
Michael mentioned that he has a retirement plan at his new job but can’t sign up until he’s worked for a year. 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 it within 60 days to avoid tax and a penalty.
Here are some pros for a workplace-to-workplace rollover:
Some cons for moving money from one workplace plan to another include:
If you left a job to become self-employed, having an IRA is a great option. However, the main pro for moving money into an account for the self-employed, such as a solo 401(k) or SEP-IRA, is that they allow higher annual contribution limits.
The main con for transferring funds to an account for the self-employed is that it may not give you as many legal protections as a workplace plan, depending on the state where you live.
Michael, the best place for your old retirement money depends on the flexibility and legal protections you want. Other considerations include the quality of your old plan, your income, and whether you have a new job with a retirement plan that accepts rollovers.
The goal is to position your retirement money where you can keep it safe and allow it to grow using low-cost, diversified investment options. If you have questions about doing a rollover, contact your old retirement plan’s custodian. They can walk you through the process to make sure it goes smoothly and that you won’t break the rollover rules.
Before we go, I want to invite you to connect with me on Twitter @lauraadams or Instagram @lauradadams. And LauraDAdams.com is my personal site where you can use my contact page and learn more about my work, books, and money courses.
That's all for now. I'll talk to you next week. Until then, here’s to living a richer life.