With all of the preparation that goes into changing jobs, you may overlook your company retirement plan. Understanding your options will help you make a decision about what to do with a 401k when changing jobs.
Decisions Must Be Made - Limited Options
Changing jobs often means signing up for new medical insurance, a disability plan and a retirement plan. What is not always evident is in the mountain of paperwork on how new employers deal with old retirement plans from previous employers. When you are changing jobs another decision that has to be made has more to do with your old employer than your new employer. Since most companies don’t offer guaranteed pension plans, most employees today have 401k plans or pension plans that employers and employees pay into. In some cases, these plans are self-directed although in most cases, the plan administrators designate the investment options.
Those who are making a career change need to deal with new retirement plans as well as the plans they had with their previous employer. This is when it’s important to understand what options are available. There are four options that are available to most employees. The first may seem the most attractive, that being to cash out the 401k and use the money for whatever purpose they want. Other options involve keeping the funds with the employer you’re leaving, rolling it over to your new employer or rolling it over to a newly established qualified rollover account. Before deciding what to do with your 401k when changing jobs, it is imperative that there is an understanding of what each of these options offers in terms of potential upsides and downsides.
The Pros and Cons of Cashing Out
As tempting as it may be to cash out a 401k plan, there are serious consequences that must be considered. First, when the withdrawal is made, there will be an automatic penalty withheld from the withdrawal. This amount is standard and is approximately 20 percent of the amount withdrawn. Depending on how long you have been employed, the penalty amount can be substantial. In addition, when you file your taxes, you will be required to claim the withdrawal and you may have to pay an additional 10 percent penalty to the Internal Revenue Service. While you may be able to roll the funds back into a qualified plan in 60 days, the problem is that if you do not put the funds back in, you will lose any tax benefits these funds offered. This is in addition to having less money available at the time you retire and losing all of the growth you would obtain if the funds remained invested.
Advantages to this of course is the immediate use of the funds. This can help bridge the financial gap between jobs, pay off high interest rate credit cards or to pay other bills. Unfortunately, these benefits will likely not be enough to offset the negative aspects of cashing out a 401k plan early.
Keeping Current Plan Intact
Another potential option is to keep your 401k plan with your current employer. This may be easier for some; however, there are some downsides to this option that must be carefully considered. One of the primary downsides of doing this is that you will not have any control over the funds or how they are invested. This method also does not allow you to borrow money against your funds, which you could do as an employee. This restriction could have an impact on employees who may be considering purchasing a home or those who have a drastic financial need such medical or college expenses.
One valid reason for keeping your funds at your current employer could be the investments that are being held in the plan. For example, some 401k plan administrators invest all (or part) of the plan participant funds into the stock of the company at a discounted rate. For these types of cases, it may be beneficial to leave the money where it is and allow it to continue growing. The problem is this may be restrictive for many employees and limits some potential as well.
Before considering this option, find out from the plan administrator if the option exists and if so, what (if any) fees will be charged to you to keep the funds intact and make sure that you have a login to access your statements or are receiving regular statements by mail.
Roll Over to a New IRA Plan
Another feasible option for dealing with your 401k plan is to roll it over into a new qualified IRA plan. These plans have a special designation as a rollover account to designate them as qualified funds. These qualified plans allow you to take money out and replace them within a specific period of time without penalty for specific reasons such as college expenses, buying your first home or other limited reasons. These funds are not considered loans by the Internal Revenue Service, instead they are treated as a withdrawal. If the funds are replaced within sixty (60) days, the penalty may be waived.
The positive side of this method is the funds are still considered qualified funds. Another plus, is that you as the owner of the account, have the right to designate the allocation of the funds to any type of investment you select. The downside is these funds cannot be added to, except with other qualified funds. One of the negative sides to these funds is they may not be used for loans, they may be withdrawn with penalties or without penalty if repaid in the time allotted.
Final and Perhaps Best Option
The final option for dealing with the problem of what to do with your 401k plan when changing jobs may be your best option. If your new plan (at the new employer) allows you to do so, you can roll the prior plan into your new plan. There are a number of benefits to this including:
Immediate vesting in the plan - The funds you rolled over from your prior plan become immediately vested. This means that 100% of those funds are available for investing with no waiting period.
Availability of loans - The funds that are from the prior employer are already vested and therefore may be used to borrow against (provided your new plan has a loan plan). This means these funds are available should you decide to buy a home, need to pay for college expenses or are faced with unexpected medical expenses.
This option may turn out to be the best possible option when you are working on your financial plans when you start a new job. Remember, everyone has a different set of financial needs and your final decision should be the one that works best for your individual needs.
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Spiegelman, Rande: Charles Schwab What to do With Your 401(k) When You Change Jobs http://www.schwab.com/public/schwab/research_strategies/market_insight/retirement_strategies/planning/what_to_do_with_your_401k_when_you_change_jobs.html
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- Ameriprise Financial Deciding what to do with your 401(k) plan when you change jobs http://budgeting-investing.ameriprise.com/financial-planning-articles/retirement-planning-information/what-to-do-with-your-401k-plan-when-you-change-jobs.asp
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