Short On Time? Here’s a Quick Summary:
- Four 401(k) Key Considerations: When leaving a job, individuals can leave their 401(k) with their previous employer, transfer it to their new employer’s plan, roll it over into a traditional IRA, or cash out the account.
- Pros and Cons: Each option has its benefits and drawbacks, such as retaining certain protections and loan features with employer plans, gaining investment choices with an IRA, or facing taxes and penalties if cashing out.
- Consider Professional Guidance: It’s essential to carefully evaluate these options and seek professional advice to make the best decision for long-term financial health.
One of the common threads of a mobile workforce is that many individuals who leave their jobs are faced with a decision about what to do with their 401(k) account.¹ Individuals have four choices with the 401(k) account they accrued at a previous employer.2
Key Consideration #1: Leave It with Your Previous Employer
You may do nothing and leave your account in your previous employer’s 401(k) plan. However, if your account balance is under a certain amount, your ex-employer may elect to distribute the funds to you. There may be reasons to keep your 401(k) with your previous employer —such as low-cost investments or limited availability outside of the plan. Other reasons are to maintain certain creditor protections unique to qualified retirement plans or to retain the ability to borrow from it if the plan allows for such loans to ex-employees.3
The primary downside is that individuals can become disconnected from the old account and pay less attention to the ongoing management of its investments.
Key Consideration #2: Transfer to Your New Employer’s 401(k) Plan
Provided your current employer’s 401(k) accepts the transfer of assets from a pre-existing 401(k), you should consider moving these assets to your new plan.
The primary benefits of transferring are:
- The convenience of consolidating your assets.
- Retaining their strong creditor protections.
- Keeping them accessible via the plan’s loan feature.
If the new plan has a competitive investment menu, many prefer transferring their account and taking a break with their former employer.
Key Consideration #3: Roll Over Assets to a Traditional Individual Retirement Account (IRA)
Another choice is to roll assets into a new or existing traditional IRA. A traditional IRA may provide some investment choices that may not exist in your new 401(k) plan.4
The drawback to this approach may be less creditor protection and the loss of access to these funds via a 401(k) loan feature.
Remember, take your time when making a decision. You have time to consider your choices and may want to seek professional guidance to answer any questions.
Key Consideration #4: Cash out the account
The last choice is to cash out of the account. However, if you choose to cash out, you may be required to pay ordinary income tax on the balance plus a 10% early withdrawal penalty if you are under age 59½. In addition, employers may hold onto 20% of your account balance to prepay the taxes you’ll owe.
Think carefully before deciding to cash out a retirement plan. Aside from the costs of the early withdrawal penalty, there’s an additional opportunity cost in taking money out of an account that could grow on a tax-deferred basis. For example, taking $10,000 out of a 401(k) instead of rolling over into an account earning an average of 8% in tax-deferred earnings could leave you $100,000 short after 30 years.5