With rising wages and a tight labor market, the last couple years have led many workers to switch jobs. That means many job-hoppers may have a 401(k) retirement plan with a former employer. Fortunately, these workplace retirement accounts are designed to be portable. However, moving your 401(k) and choosing when to do so may be more challenging than you realize.
If you’re changing jobs or have been laid off, chances are that your 401(k) account is the last thing on your mind. But it pays to include that money in your moving plans – even if you don’t deal with it right away. Once you’re ready to focus your attention on what to do with your old 401(k), here are eight things you need to consider.
1. If you have an outstanding 401(k) loan
Did you borrow any money from your 401(k)? If you did and you’re leaving the company, voluntarily or otherwise, you “have the option to repay the loan to an IRA and you have until your personal tax return deadline of the following year [including extensions] to contribute that repayment amount to an IRA” thanks to the 2017 Tax Cuts and Jobs Act, explains Mat Sorensen, CEO of Directed IRA and Directed Trust Company.
If you can’t (or don’t) pay the loan back in the allotted time, “the plan will reduce your vested account balance in order to recoup the unpaid amount,” says Ian Berger, IRA Analyst with IRAHelp.com. “This is called a loan offset.”
“I think that many people forget that if they have a loan outstanding, it has to be paid,” says Wayne Bogosian, co-author of “The Complete Idiot’s Guide to 401(k) Plans.”
Fail to repay it and the loan amount will count as income, potentially subject to tax, plus you’ll pay an additional penalty equal to 10 percent of the sum you borrowed if you’re younger than age 59 ½, says Bogosian.
Taking a loan from your 401(k) is really borrowing from yourself and may be an appropriate decision for some people who are unemployed with no income source, need money for medical expenses, or are purchasing their first home. However, there are many things to consider before doing so.
If you can’t pay the loan back to your 401(k), other than the potential tax implications listed above, the options below still apply.
2. What options do I have for my current 401(k)?
When you leave an employer, you have several options:
- Leave the account where it is
- Roll it over to your new employer’s 401(k) on a pre-tax or after-tax basis
- Roll it into a traditional or Roth IRA outside of your new employers’ plan
- Take a lump sum distribution (cash it out)
The truly smart move for you depends on your own individual circumstances and goals.
Some items to consider include:
- Your current account balance
- Whether you fear collection actions, because workplace retirement plans provide creditor protection that IRAs don’t
- The quality of your new company’s retirement plan versus your former plan in terms of investment options, fees and whether loans are permitted
- Investment options available to you in an IRA outside of your employer’s plan
The good news is that you don’t have to make any decisions about your existing 401(k) immediately. You may want to speak with a financial advisor first to discuss your options.
3. You may be able to leave your account with your former employer, at least temporarily
Changing jobs is stressful, even in the best of circumstances. If you’ve lost a job and are scrambling for re-employment, you’re likely focused on that. But eventually you will need to figure out what to do with your 401(k).
If your balance is $5,000 or more, you can leave the money right where it is, giving you time to decide the best course of action for you. In this case, you’re under no obligation to move your money.
What you should do right away, regardless of the 401(k) balance in your old plan, and as early as your first day at the new job, is to sign up for your new company’s 401(k) plan. Even if your new employer has an automatic opt-in feature that does not kick in for one to three months — and if you rely on that, rather than taking the initiative — you can miss 30 to 90 days of contributions and matching funds, Bogosian advises.
After six months, you’ve got a handle on the job, know you’re going to stay and have some experience with your new plan. You’re now in a better position to compare your last 401(k) plan with this new one, including the diversity of the investments and the costs.
But what happens if the balance in your old 401(k) is less than $5,000? Your former employer may force you out of the plan by placing your funds in an IRA in your name or “cashing you out” and sending you a check.
Some companies have recently adopted auto-portability, meaning your small balance may automatically transfer to your new employer’s plan. Check with your HR Department or plan sponsor to see if this applies.
4. Compare plan costs
In the not-so-distant past, comparing the cost you pay for investments through one company’s plan with similar offerings in another company’s 401(k) or in an IRA was difficult.
Now fees and costs have to be disclosed, which means you can compare apples to apples. As you compare the plan costs, ask for the participant fee disclosure for each plan. That document will reveal all the fees — both obvious and obscure — associated with each plan.
Then look at what you’ve invested in and what you want to invest in, to help evaluate costs. At this point you will have a better idea if you want to keep your old 401(k) invested with your former employer, roll it over into your new employer’s plan or roll it into an IRA.
5. Keep tabs on the old 401(k)
If you decide to leave an account with a former employer, keep up with both the account and the company. “People change jobs a lot more than they used to”, says Peggy Cabaniss, retired co-founder of HC Financial Advisors in Lafayette, California. “So, it’s easy to have this string of accounts out there in never-never land.”
Cabaniss recalls one client who left an account behind after a job change. Fifteen years later, the company had gone bankrupt. While the account was protected and the money still intact, getting the required company officials and fund custodians to sign off on moving it was a protracted paperwork nightmare, she says.
“When people leave this stuff behind, the biggest problem is that it’s not consolidated or watched,” says Cabaniss.
If you do leave an account with a former employer, keep reading your statements, keep up with the paperwork related to your account, keep an eye on the company’s performance and be sure to keep your address current with the 401(k) plan sponsor. (Here’s how to find other unclaimed money.)
Keeping on top of how the plan is performing is important, as you may later decide to do something different with your hard-earned money.
6. Follow the money
If you do decide to move the money by rolling it into your new employer’s plan, there are a number of ways to get support and assistance.
Hopefully you’ve already begun contributing to your new employer’s plan, and if so, the rollover will be facilitated by the new plan. If you have not yet begun contributing, contact your new employer’s HR Department to get enrolled. They can guide you on how to initiate a rollover to the new plan.
All plans have someone dedicated to assisting participants with rollovers, so put them to work for you. These folks are experts with rollovers and can ensure that the rollover goes smoothly. There is paperwork that you need to complete, and they will guide you through what needs to happen and when.
You have 60 days to re-deposit your funds into a new retirement account after it’s been released from your old plan. If this does not occur, you can be hit with tax liabilities and penalties.
Remember that if your funds are sent to you, and the check is made out to you or the new custodian (plan sponsor), do NOT cash it. Get it to the new custodian ASAP.
Keep notes on who you spoke to and when. Be sure to follow up until your money is safely in its new home and that you have written proof.
7. Rolling into an IRA? Stay on top of the move
If you decide to roll over your 401(k) into an IRA, your IRA sponsor or advisor will help guide you through the process to ensure the money gets to the proper destination in a timely manner. (The same 60-day deadline to re-invest applies here as well.)
Be sure your new broker or advisor has experience with rollovers, especially if you have company stock in your 401(k). Why? Because company stock is liquidated when it’s rolled into an IRA, and later, when distributed, may be taxed as ordinary income resulting in a higher tax liability.
As recommended above, stay vigilant until your money is safely in its new home and that you have proof — typically verified online through the IRA provider’s website.
8. Cashing out a 401(k) is popular, but not so smart
Intellectually, consumers know that cashing out retirement accounts isn’t a smart move. But plenty of people do it anyway. As discussed, you may be forced out of your former plan based on your account balance, but that doesn’t mean you should cash the check and use it for non-retirement-related purposes. In the long run, your financial future will be better served by rolling the money over into an IRA or, if applicable, your new employer’s 401(k) plan.
A 2020 survey by Alight, a leading provider of human capital and business solutions, found that 4 out of 10 people cashed out their balances after termination between 2008 and 2017. About 80 percent of those who had an account balance of less than $1,000 cashed out, while 62 percent who had balances between $1,000 and $5,000 did the same.
Based on historical rates of return, a $3,000 cash-out at age 24 leads to $23,000 less in your projected account balance at age 67 – a total of 5 percent. Even a small amount of money invested into a retirement vehicle today can make a big difference in the long run.
How much of your 401(k) do you get when you leave an employer?
You are entitled to 100 percent of any contributions you’ve made into the 401(k) plan, but how much of an employer match you’re entitled to is based on how the plan is set up and the vesting period. A vesting schedule is based on the length of time required to have ownership (or vest) in the employer’s contributions. If you are 100 percent vested in employer contributions, you will receive all of the money the company has contributed on your behalf.
If you have not been with the company for the required amount of time, you may receive a percentage of employer contributions, based on the plans’ vesting schedule. The rest of the money set aside for you is forfeited back to the company. Most 401(k) providers delineate how much of your balance is fully vested. If you’re not sure, you can always call to inquire.
Finally, whether you roll over your 401(k) to an IRA, move it to your new employer’s plan or let it stay with your old employer, the important point is to keep that money set aside for retirement. By keeping it in those specialized retirement accounts, you’ll enjoy a tax advantage and accumulate more money for retirement.
Whether you have set aside a lot or a little, time can work its magic on all amounts of money. Your future self will thank you for keeping the funds invested for its intended purpose.
— Dana Dratch also contributed to the initial version of this story.