Stephen P. Polizzi, CFP®, CRPC, Financial Planner
June 28th, 2017 | 12:15 PM
When Jane decided to make a career change and resign from her employer of 20 years, it wasn’t without much consideration. This included meeting with her financial advisor. Noting the sizable balance in her 401(k) plan, he said it was important to effectively manage this retirement nest egg. If you’re in a position similar to Jane’s, you have a few options.
TAKING NO ACTION
This is the simplest course of action, but it might not be the best. Your ex-employer may restrict your ability to make changes to your portfolio, to take distributions or to update beneficiaries. As a non-active participant, you may incur higher fees and receive less effective communications about plan changes than active participants do. And you’re limited to whatever investment options the plan offers.
However, if the plan offers an appealing and hard-to-duplicate investment option, it could make sense to keep your money there. Such options might include a high-yielding guaranteed investment contract or a stable value plan.
ROLLING OVER FUNDS
Rolling over your savings to your new employer’s plan can help you avoid the potential downsides of sticking with your old plan or the complications of keeping track of multiple plans. But first, review the investment options available in your new employer’s plan. In addition, be aware that you may incur a sales charge on the rollover.*
If the investment options from your new employer’s plan aren’t very attractive, you might be better off keeping your existing savings in the old plan — or rolling them over to an IRA (see the next option) — while also contributing to your new plan.
If a rollover to your new employer’s plan seems like the best option, confirm that the new plan accepts rollovers. If it does, request a direct trustee-to-trustee rollover.
Otherwise, your old employer will mail a distribution check to you, minus mandatory tax withholding of 20% that you won’t need. You then have just 60 days to deposit these funds in your new plan. You also must deposit the 20% that was withheld for taxes, which means finding cash elsewhere, because you won’t get your withholding back until after you file your annual tax return.
If you fail to meet the deadline, or if you don’t have the cash available to cover the taxes that were withheld, you must pay income tax on the amount that wasn’t rolled over. You may also incur a 10% early-withdrawal penalty if you’re under age 59½.
OPENING AN IRA
Transferring your retirement savings into an IRA offers several advantages. An IRA typically provides a wider array of investment options than most 401(k) plans do, such as mutual funds from a variety of companies, as well as individual stocks and bonds. Holding all of your assets in one account or with a single financial services company also makes it easier to get a clear view of your entire retirement savings portfolio.
Most financial services companies will accept a direct transfer of your retirement savings, which can streamline the process and avoid the potentially costly mistakes previously discussed. In many cases, assets can be transferred “in kind,” meaning you don’t need to sell the investments and then repurchase them in your IRA. Be aware, however, that you may be charged an annual fee.
Cashing out your retirement savings typically isn’t recommended. Any distributions you take will be taxed as ordinary income, and, if you’re under age 59½, you may have to pay an additional 10% penalty.
There are exceptions to the penalty in cases of economic hardship or separating from service after age 55. But in either case, you’ll still owe the income tax. In addition, although IRA distributions are exempt from the 3.8% net investment income tax (NIIT), they’re included in modified adjusted gross income (MAgI) and could trigger or increase the NIIT on other income. This is because the thresholds for that tax are based on MAgI.
MAKING THE RIGHT MOVES
If you’re considering a job change or have changed jobs recently, don’t forget that a change to your retirement savings might also be warranted. Making the wrong move can significantly harm your retirement nest egg.
* When considering rolling over the proceeds of your retirement plan to another qualified option, such as an IRA, please note that you have the option of leaving the funds in your existing plan or transferring them into a new employer’s plan. You should consult with the human Resources department of the applicable employer to learn about the options available to you under your plan and any applicable fees and expenses. Tax consequences might apply if you were to withdraw the funds, and there are additional tax consequences to transferring stock out of your retirement plan. Please consult with a tax advisor before taking such an option. You should also know that, depending on the state where you reside, assets held in a retirement plan may enjoy greater protection from creditors than in other types of tax-qualified vehicles. You should also consider the different fees and the different services that apply to your plan and compare them to any new option that you are considering.
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