Despite signs of a slowing job market, Americans — especially younger people — continue to change jobs. According to a recent Prudential Pulse survey, about a third of millennials have changed jobs since the pandemic began. Among Gen Z workers, almost half have changed employers and 18% have experienced more than one job change during this period.
While changing employers is generally the most reliable way to increase your earnings – Pew Research found that 60% of workers who changed jobs between April 2021 and March 2022 got a raise, compared to 47% of workers who stayed with the same employer – it’s important to make sure that pursuing a higher salary doesn’t come at the expense of your retirement goals.
A new employer means a new retirement benefits system, which means the more points you add to your resume, the more employer-sponsored retirement accounts you can accumulate. Just as you would approach a new job offer with a strategy to negotiate the best salary possible, your retirement goals will also benefit from a coordinated strategy.
What can you do with an old 401(k)?
When you leave an employer and have a 401(k) — or another tax-advantaged retirement account such as a 403(b) or 457(b) — you can usually do one of three things:
- leave it where it is
- Roll it into an IRA
- Roll it into your new employer’s pension plan, if your new job offers one and allows rollovers
There are a few considerations and caveats for each option.
When leaving it alone makes sense
There’s something to be said for leaving the account where it is, says Brian Kuhn, senior vice president and financial adviser at Wealth Enhancement Group. “Leaving it where it is has the advantage of being the least work,” he points out.
Also, if you’re happy with the performance of your investments or if your new employer’s plan doesn’t offer as many attractive options, it may be a good idea to keep an old retirement account. Just make sure the plan administrator won’t charge you higher fees because you’re no longer an employee. Not everyone does, but it’s a potential cost you don’t want to overlook.
Keep in mind, however, that if your account contains less than $5,000, you may not be able to keep the money in this plan: some plans don’t allow former employees to keep a small 401(k) balance on their books. Ideally, this is something you should find out early enough to have time to set up an Individual Retirement Account (IRA) if your new job doesn’t give you access to a qualified retirement plan.
Good reasons to roll
Leaving your old 401(k) in an old company’s plan has a downside: the need to keep tabs on multiple retirement accounts in order to get an overall picture of your financial situation. If organization isn’t your forte, this might be a point in favor of carrying over this balance.
Whether it’s best to transfer the money into a new employer’s plan or into an IRA with a brokerage, credit union, or other financial institution depends on a few factors.
The benefits of choosing an IRA
IRAs win for the variety of investment options, says Rachelle Tubongbanua, vice president and private wealth adviser at US Bank Private Wealth Management. “Whether [investors] were to enter a 401(k), they are limited to the funds available in that plan.
Within an IRA, you can invest in ETFs, individual stocks and bonds and, if you open a self-directed IRA, alternative asset classes not typically offered in 401(k) plans, such as real estate or precious metals.
ETFs can be more beneficial than mutual funds because they tend to be passively managed – more automation on their end means less expense for you. “ETFs will provide that diversification you need at a lower cost,” says Tubongbanua.
Benefits of choosing a 401(k)
A 401(k) might be a better choice if your new employer offers financial planning or counseling services. If you don’t plan to actively manage your portfolio, having professional advice could help you achieve better long-term results. Also, if you plan to borrow against your nest egg, you’ll need that money in a 401(k) as opposed to an IRA.
If you anticipate a lot of job changes in your career, keep in mind that transferring a 401(k) balance to an IRA to which you contribute other funds could make it difficult to return to a 401(k) because The IRS has different rules for handling money and dealing with investment gains from different sources.
“The main point is to keep the assets separate,” says Chad Parks, founder and CEO of Ubiquity Retirement & Savings. “It’s almost better to open an IRA separately just to keep that money” from an old 401(k) if you plan to want to transfer it to another employer plan in the future, he advises.
Direct or indirect bearings
If you decide to transfer your money, financial advisers say a direct rollover – in which the old and new plan administrator coordinate directly with each other – is the way to go. You’ll have to fill out paperwork and possibly phone one or both companies, but the funds in that account never technically pass through your hands.
The alternative is an indirect rollover: the old plan pays the 401(k) balance directly to you, at which time the countdown begins. You have 60 days to safely get these funds back into a new eligible account, otherwise the IRS will consider the activity a pre-withdrawal. If you’re under 59.5, this immediately exposes you to income taxes owed on that money, as well as a 10% early withdrawal penalty.
The other pitfall is that while you’re sure you can complete the rollover transaction in time to meet the 60-day deadline, you’ll need to come up with a potentially large sum of money. Plan administrators must withhold 20% of the account balance in case you miss the deadline or decide to keep the money. If you complete your rollover on time, you’ll get the money back when you do your taxes the following year — but since you have to deposit your entire old 401(k) balance into the new account, that means you have to get this 20% from another source to make the whole account.
“Indirect turnover is definitely something you want to try to avoid,” says Kuhn of Wealth Enhancement Group.
Never do this with an old 401(k)
Financial experts agree on one thing: it’s always a bad idea to cash in a retirement account. You’ll immediately have to pay federal and state taxes on that money — and the balance is large enough that you could inadvertently put yourself in a higher tax bracket. Additionally, you will incur this 10% early withdrawal penalty if you are under age 59.5.
“Worst-case scenario, you can look at 40% to 50% being paid in taxes,” Parks says. “It really isn’t worth it unless there’s an absolute emergency.”
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Retire With Money brings the latest retirement news, insights and advice to your inbox. Jill Cornfield has been covering retirement for over 10 years.
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