When you leave a job, deciding what to do with your old 401(k) or other Qualified Retirement Plan (QRP) from your previous employer can at first seem to be a complex task. There are typically three options you can choose from. Below you will find information on what your options are, and some key decision-making factors that can help you determine which is best for you.
The three options are:
Leave your savings in your previous employer's plan
Transfer the balance to your new employer's plan
Roll over your balance into an individual retirement account (IRA)
Option 1: Do Nothing
If you're happy with the investment options in your previous employer's plan, you can generally leave your retirement savings in your previous employer’s 401(k) as long as your balance is greater than $5,000. However, if your balance is less than that, your employer may require you to take your money and choose another option. People generally only leave their assets with their previous employer if they are very happy with the investment options in the 401(k) plan.
No need to make any changes or decisions.
Keep your savings invested in your current investments.
If your previous employer offers freedom to invest in a wide range of stocks, bonds, and ETFs, this option allows you to continue to have freedom over how you invest your money.
You won't be able to contribute to the old plan anymore.
You may have to pay extra fees, especially if your new employer's plan offers lower fees or other incentives.
You'll need to keep track of multiple retirement accounts from different employers.
Option 2: Transfer the Balance to Your New Employer's Plan
If your new employer offers a QRP and you're happy with the investment options available, you can transfer your balance to the new account. However, some employers have a probation period before your retirement benefit goes into effect, so take this into account before you decide what to do.
Consolidate your retirement savings into one account.
You'll have the ability to make contributions to a new plan.
If your new employer's plan offers better investment options or lower fees, this option can be a great way to maximize your savings.
Generally limited investment options compared to an IRA.
You may have to pay additional fees or penalties for transferring your balance.
Your new employer's plan may not offer as much flexibility as your old plan.
Option 3: Roll Over Your Balance into an IRA
You also have the option to roll your QRP into an IRA. An IRA is a retirement account that is not tied to your employer. An individual can contribute $6,500 a year to an IRA or $7,500 if over 50, and these contributions can potentially be deductible, subject to income level constraints. Just because you open an IRA doesn’t mean you can’t contribute to your new employer’s 401(k) or qualified retirement plan. An individual can contribute to both a 401(k) and an IRA—they just might not be able to deduct their contribution to their IRA if they make too much.
Additionally, you could decide to roll your balance into a Roth IRA via a Roth conversion. This option, however, only makes sense for those who are willing to pay tax on the balance at the time of the conversion. A Roth IRA is funded with after-tax dollars, so you pay tax on the money going in, but when you withdraw the money in retirement, it is not taxed.
One of the biggest pros to rolling over your 401(k) or QRP into an IRA is there are generally more investment options at your disposal. While employer-sponsored retirement plans tend to have limited investment options, IRA account owners can invest in stocks, bonds, mutual funds, etfs, etc.
Access to a wider range of investment options than a QRP.
No fees or penalties for rolling over your balance.
You can choose your own financial institution and investment strategy.
You can still contribute to your new employer plan and maintain your IRA.
Potentially roll balance into a Roth IRA
No contributions from an employer.
You may have to pay extra fees if you don't choose a low-cost IRA provider.
Will have to self-manage the account if you don’t hire an advisor/wealth manager.
Direct vs. Indirect Transfers
It's important to note that when transferring your balance from one plan to another, there are two options: a direct transfer and an indirect transfer.
A direct transfer is when the balance is moved by your ex-employer or account administrator straight to your new retirement account. This does not trigger any taxable events and is not considered an early withdrawal.
An indirect transfer is when your ex-employer or account administrator liquidates the holdings and cuts you a check for the balance of the account. This will trigger what's known as the 60-day rule. In this instance, you'll have 60 days to transfer the money into the new account.
If you are under the age of 59 1/2 and you fail to transfer the money in that time frame, you will be penalized 10% for an early withdrawal, in addition to the taxes you must pay on the withdrawal amount.
Choosing what to do with your 401(k) or QRP account when leaving a job largely comes down to what you value in a retirement account. While it may seem daunting at first, with a little bit of research and planning, it can be a relatively simple process. By understanding the available options and choosing the right one based on individual circumstances, employees can ensure that their retirement savings continue to grow and work towards their long-term financial goals.
Consider the pros and cons of each option, and don't hesitate to consult Aspen Investment Management before making a decision.