If you have a 401(k) with a former employer, besides cleaning out your desk, it’s necessary to determine what to do with your money once you exit the company. A variety of options are available, each with their advantages and disadvantages.
Considering that making the wrong decision when it comes to your investment savings can cost you big money, it pays to carefully weigh your options before making any moves.
Don’t Cash Out!
Unless you’re in dire need of some funds, cashing out is not a wise move. Besides the fact that you spend your retirement savings, the financial consequences can be costly. If you cash out before age 59 ½, the money is subject to federal and sometimes state income taxes, along with a 10 percent early withdrawal penalty.
To make matters even worse, if the cash taken out is substantial, you may end up in a higher income tax bracket this year. That means paying more income taxes next year. If you really must withdraw cash, take out only what you absolutely need, and nothing extra.
If you can, leave the money where it is
Keeping your money in your former employer’s fund is often possible, but it does depend on the plan. Consider the following pros and cons of leaving your money where it is.
- You can no longer make contributions
- It can take more effort to stay abreast of what’s happening with your account
- There may be a minimum balance requirement. If your account contains below the limit, your former employer may distribute the money to you or place it in an IRA opened on your behalf.
- Transaction and withdrawal limits generally apply
- Your former employer’s plan may have excellent investment options available
- You are eligible for penalty-free withdrawals from your 401(k) if you quit your job in the year you turned 55 or after.
- Your former employer’s plan generally allows you to take out loans on your 401(k), which is nontaxed money, providing you repay the loan
Roll it over into your new employer’s 401(k) plan
If your new employer accepts rollovers from previous employer plans, this could be a good choice for you, especially if the new employer’s 401(k) plan has a broader range of investment options. Consolidating also makes managing your investments more convenient and easier.
Disadvantages to rolling over into a new employer’s plan are that the investment range may be more limited. Another potential disadvantage is if you aren’t sure if you’ll be staying with the new employer for an extended period of time.
Roll it over into an IRA
Rolling over your 401(k) into an IRA is often your best option, because the fees may be lower and there will be more investment options available to you. In certain circumstances, you can also withdraw money from your IRA without early withdrawal penalties. This is possible for educational expenses, as a first-time homebuyer and if you are unemployed and need to pay for health insurance.
Remember the details!
When you rollover to a new employer’s 401(k) or an IRA, be aware of how the transfer is made. If possible, request a direct rollover from your former employer’s 401(k) to the new plan or IRA. This is referred to as a trustee-to-trustee rollover. If their policy is to write a check, make certain it is made out to the investment firm where your IRA is located or your new employer’s 401(k) plan. If your name is on the check, your former employer will be required to withhold 20 percent for taxes.
Don’t ignore your 401(k), especially when you leave your job. Review your options and make the most of your investment, because no one else will.
Julie Bawden-Davis is a widely published journalist specializing in personal finance and small business. She has written 10 books and more than 2,500 articles for a wide variety of national and international publications, including Parade.com, where she has a weekly column. In addition to contributing to SuperMoney, her work has appeared in publications such as American Express OPEN Forum, The Hartford and Forbes.