You’re Leaving Your Job: What Happens to Your Retirement Account?Submitted by MIRUS Financial Partners on February 19th, 2020
When you leave a job, you don’t just leave your coworkers behind. You also leave a retirement plan. However, retirement plans don’t have to stay with your previous employers. There are many reasons you may want to consider moving these funds into other retirement savings vehicles (a rollover). In this article, we’ll discuss what a rollover is, the different types of rollovers, and the other investment options available to you.
In the financial world, a rollover is the movement of funds from one retirement savings vehicle to another. You may move from one 401(k) to another, or you may choose to move your funds into a different type of investment vehicle.
While leaving a job is the most common reason to consider a rollover, rollovers are also options if you want to switch investments or you've received death benefits from your spouse's retirement plan.
It’s important to know that some distributions can't be rolled over, including the required minimum distributions (to be taken after you reach age 70 1⁄2 or, in some cases, after you retire. There are restrictions on certain annuity or installment payments, hardship withdrawals, and corrective distributions of excess contributions and deferrals. If you’re not sure if these apply to you, an experienced financial advisor can help.
The Indirect, or 60-Day, Rollover
Retirement funds can be rolled over in two ways–the indirect (60-day) rollover and the direct rollover (or trustee-to-trustee transfer). With the indirect method, you start by receiving a distribution from your retirement plan. Once the funds are in hand, you must deposit the funds into the new retirement plan account or IRA within a 60-day period. Regulations allow rollovers at any age.
When executed properly, there is no income tax on rollovers. However, if you fail to complete the rollover or miss the 60-day deadline, you may be subject to a 10 percent early distribution penalty. If you’re older than 59 1⁄2, exceptions apply.
Additionally, if you receive a distribution from an employer retirement plan, your employer must withhold 20 percent for taxes. In you provide that 20 percent from other sources, to ensure 100 percent of your investments go into the new retirement savings vehicle, that amount will be deducted from your taxable income.
The Direct Rollover, or Trustee-to-Trustee Transfer
The second type of rollover transaction is a direct transfer of funds. It occurs directly between the trustee or custodian of your old retirement plan and the trustee or custodian of your new plan or IRA. In this type of transfer, you never receive the funds or have control of them. As a result, a trustee-to-trustee transfer is not taxed in the same way as a distribution. This means that when you initiate a direct rollover, you no longer have to worry about the 60-day deadline or the 20 percent withholding considerations.
Whenever you are eligible for a distribution from your employer's retirement savings plan, they are required to offer the option of making a direct rollover to another employer retirement savings plan or IRA.
Because the money is moved directly from one retirement savings vehicle to another without issues of withholdings or taxation, a trustee-to-trustee transfer can be the most efficient way to move retirement funds.
Review Your Rollover Options
Once you leave a job, you can handle your retirement savings plan in a variety of ways. There are pros and cons to each option.
Should You Consider an IRA?
On one hand, many employer plans offer limited investment options, often selected by the employer. Conversely, IRAs offer a wide variety of investment choices. Employer plans are often strict about distribution options, but in an IRA (especially for your beneficiary following your death) you usually have more flexible options.
Every financial situation is different, but some people may find that they save a lot in management fees and administration fees when they roll over into an IRA.
IRAs also make sense for many estate plans. 401(k)s are often paid in one lump sum to beneficiaries, while IRAs usually offer more payout options. This could reduce taxes for your heirs. Again, each person and situation is different, so talk to a financial advisor before moving your funds to ensure you get the maximum tax benefits.
Should You Rollover to Your New Employer’s Plan?
For some people, an employer’s plan administrator managing your retirements saving is convenient. The contribution ceilings are also higher on 401(k)s vs. IRAs.
Moving funds into a new employer’s plan also makes sense if the new plan is a good one with lots of investment options and low fees.
Also, make sure the plan’s options work with your retirement savings goal. If you plan to continue to work after age 72, keeping your funds in a 401(k) allows you to delay taking your required minimum distribution.
However, if your new employer offers a SEP IRA or SIMPLE IRA, you may need to observe a waiting period and consider other conditions before moving your 401(k) funds into their IRA-based retirement savings programs.
Finally, rollovers into your new employer’s sponsored retirement savings plans may offer better creditor protection. In general, federal law protects IRA assets up to $1,362,800 (scheduled to increase on April 1, 2022)—plus any amount rolled over from a qualified employer plan or 403(b) plan—if bankruptcy is declared. Assets in a qualified employer plan or 403(b) plan generally receive unlimited protection from creditors under federal law, regardless of whether bankruptcy is declared. SEP and SIMPLE IRAs are not included in or subject to this limit and are fully protected under federal law if you declare bankruptcy.
Should You Keep Your 401(k) Plan With Your Previous Employer?
Some employers allow past employees to keep funds in their 401(k)s after the employee leaves. This option may make sense if your new employer doesn't offer a 401(k) or offers a plan with fewer advantages.
If your 401(k) plan account has substantially outperformed the markets over time, you may want to keep your funds in place. When you leave your job in or after the year you reach age 55 and plan to start withdrawing funds before turning 59 ½, the withdrawals will be penalty-free. Additionally, if you plan to be self-employed, it may make sense to keep your funds in your previous employer’s 401(k).
However, some people find it complicated to track several different accounts connected to different places of employment. You won’t be able to continue to contribute or get employer matches. In some cases, you’ll no longer be able to take a loan from the plan or take partial withdrawals.
Should You Cash Out Your 401(k)?
Cashing out may be tempting, but there are many penalties involved. Your withdrawal will be taxed at your current tax rate. Unless you’re 55 years old and planning to stop working, you may have to pay an additional 10 percent penalty. Working people can withdraw without that 10 percent penalty after reaching age 59 ½.
Want to learn more about how to maximize the benefits of a retirement account? Check out these articles;
The SECURE Act and What it Means for Your Retirement