Options for Retirement Savings Plan When Leaving or Changing Jobs
Submitted by MIRUS Financial Partners on February 25th, 2022If you’re one of the millions of Americans who are leaving or changing jobs this year, you have a lot to consider. People who have a tax-deferred retirement account through their employers, such as a 401(k), 403(b), or 457(b) plan, must decide how to handle those savings moving forward. There are many options, and each one has its own set of advantages and disadvantages.
In general, you have the following four options when you're eligible to receive a distribution from your employer's retirement savings plan because of a change in employment status.
Roll the Funds Over to an IRA
You can move your funds from your employer's retirement account into an IRA. While distributions from designated Roth accounts can be rolled over only to a Roth IRA, distributions from non-Roth funds can be moved into a traditional IRA or converted to a Roth IRA. This allows you to benefit from continued tax-deferred (or tax-free) growth.
While every plan is different, IRAs usually offer more investment choices than an employer plan. You can freely move your money among the various investments offered by your IRA trustee, and you can freely move your IRA dollars among different IRA trustees/custodians (using direct transfers)
With an IRA, the timing and amount of distributions are generally at your discretion (however, you must start taking required minimum distributions from traditional IRAs at age 72) Finally, some types of IRAs don’t require distributions during your lifetime.
If your distribution is eligible for rollover, you'll receive a statement from your employer outlining your options. Read that statement carefully. You cannot roll over hardship withdrawals, required minimum distributions, substantially equal periodic payments, corrective distributions, and certain other payments.
Roll the Funds Over to Your New Employer's Plan
Some new employers allow you to roll over your retirement account from a previous employer. When evaluating this option, ask about possible surrender charges that may be imposed by your existing employer plan or new surrender charges that your IRA or new plan may impose. It’s also smart to compare investment fees and expenses charged by your IRA (and investment funds) or new plan with those charged by your existing employer plan (if any.)
Make sure you understand any accumulated rights or guarantees you may give up by transferring funds out of your employer plan. Some plans offer eligibility for a plan loan, and you may be able to delay required distributions beyond age 72.
It’s not always easy to evaluate the pros and cons of transferring funds from one employer plan to another. It’s wise to have a financial professional assist you with this decision to avoid unexpected short-term or long-term economic consequences.
As noted earlier, if your distribution is eligible for rollover, you'll receive a statement from your employer outlining your rollover options. You cannot roll over hardship withdrawals, required minimum distributions, substantially equal periodic payments, corrective distributions, and certain other payments.
Leave the Money in the Plan
Some employees choose the most straightforward option: leaving the money untouched in the employer’s retirement plan. If you choose this option, you won’t need to do anything other than ensure you have continued access to your account.
There are reasons to leave your money in an employer’s plan after exiting the company. Sometimes an employer plan offers certain investment opportunities that you can't replicate with an IRA. While IRAs typically provide more investment choices than an employer plan, this is not true in every case.
Leaving the money in the plan means it continues to offer tax-deferred growth (or potentially tax-free growth in the case of Roth accounts.) Contributors can receive penalty-free distributions from a 401(k), 403(b), or 457(b) plan as early as age 55 (50 for qualified public safety employees) compared with age 59½ for IRAs.
Finally, qualified plans generally provide greater creditor protection than IRAs. However, leaving your funds in an employer account might not be an option if your vested plan balance is $5,000 or less, if you've reached your plan's normal retirement age, or if the payment is a required minimum distribution. Consult your plan's terms for details.
Take the Distribution in Cash (and Securities if Applicable)
Most plans allow you to take a lump-sum distribution of your account balance when leaving an employer. While taking a cash payout may seem appealing, especially if you are unexpectedly exiting the job, there are a few considerations to consider.
For employees with a distribution that includes employer stock or other securities, special tax rules may apply in ways that make taking a distribution more advantageous than a rollover into an IRA or other retirement account. Consult a tax professional to evaluate your options.
For people who are not dealing with company stock or other securities, taking a distribution is a risky choice. All or part of your distribution may be subject to federal (and possibly state) taxes. The taxable portion may be subject to an additional 10% early distribution penalty tax if you haven't reached age 55 (50 for qualified public safety employees). The combined amount of taxation and penalties reduce the total value of your retirement funds.
When you withdraw your savings from an employer retirement account or an IRA, you’ll lose a tax-free account, and you’re liquidating part (or all) of your retirement savings. Once you cash out of an account, you lose the benefit of continued tax-deferred (or tax-free) growth.
Partial Rollovers
The good news is that employees don’t have to choose just one option. You don't have to roll over your entire distribution. Instead, you can rollover whatever portion you wish. If you roll over only part of a distribution that includes taxable and nontaxable amounts, the amount is treated as coming first from the taxable part of the distribution. Talk to a financial professional to see if this option works with your retirement goals.