Thinking about changing jobs or retiring? Be sure you take all of your “nickels and dimes” with you when you leave. If at all possible, pull your retirement accounts out — don't leave them behind in your former employer's plan.
Why does this matter?
- Your former employer could get swallowed up or merge with another company, displacing the HR department and potentially changing the retirement plan in the process.
- Your investment choices will be limited to what's available in the plan.
- Human nature being what it is, you could forget that it's there, become disinterested, or — worse yet — not include those assets in your long-range financial planning.
Unless there's a compelling reason to leave it with your former employer — for example, maybe you have an outstanding loan that you can continue to pay off even after you've terminated your service — then it's generally better to either move it to your new employer's plan or roll it over into an IRA. In either case, those funds will continue to grow tax-deferred, and you can keep your eye on them.
Your retirement plan will typically offer several distribution options when you leave. This article will walk through some of the choices you'll be presented with.
What Makes Sense For You?
When you leave your current employment, you will likely receive a bunch of paperwork on how to take a distribution from your plan. Here are the most common options:
- Keep your money in the plan.
Depending on your plan's rules, if your account balance is more than $5,000 then you can opt to leave your money in your employer's retirement savings plan. If the account balance is less than $5000, you might not have an option and be forced to take the funds out anyway. If you choose to keep the funds in the plan, you'll continue to enjoy tax-deferred compounding of any investment earnings, and you'll receive regular financial account statements. You won't be allowed to contribute to the plan, but you'll still have control over how your money is invested among the plan's investment options. You might also be allowed to work with and obtain information from the professionals that manage and administer your account.
If you are starting your own business, keeping your retirement money in your former company's plan can help protect your retirement assets from creditors, should your new venture run into unforeseen trouble. Alternatively, as a business owner, you could also elect to set up your own 401(k) plan. This can also protect your retirement assets from creditors and allow you to do a tax-free rollover into a qualified plan and keep those funds under your watchful eye.
- Move your money to another retirement account.
You also have the option to move your money into another qualified retirement account, such as an Individual Retirement Account (IRA), or your new employer's retirement savings plan. With this kind of "direct rollover", the money goes directly from your former employer's retirement plan to the IRA or new plan, and you never touch it. This means no taxes and no penalties. As an added bonus, you will continue to defer taxes on the full amount of your plan savings. Keep in mind: if you have a loan outstanding against your plan and you haven't repaid it before leaving, you could wind up with a tax bill on the unpaid balance of the loan.
- Take a cash distribution.
Finally, you could also elect to have your money paid directly to you. Depending on your plan provisions, you might receive your funds in one lump sum, in several installments of a fixed amount, or paid out over a set number of years. Keep in mind that the distribution will be reportable as income and you will be liable for all Federal and State taxes. If you are younger than age 59½ (or 55 in some circumstances — check with your tax and/or financial advisor), you might also have to pay an additional 10% Federal tax. In a lot of cases, people are shocked to find that they wind up with only about half of their requested distribution once taxes are taken out.
As you can see, decisions about taking a retirement account distribution are not always open-and-shut. Be sure to speak with your tax and/or financial planning professional before taking any actions. This is one area you don't want to delve into on your own because any actions you take could be difficult to undo.