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Changing jobs can be a daunting, yet exciting process. Once you’ve handed in that two-week notice, preparation for the change officially begins – just make sure you have room on your to-do list for how to handle your former employer’s 401 (k) plan.
It’s actually quite easy to forget about your 401 (k) balance. According to a study by Capitalize, a fintech company, there are approximately 24.3 million forgotten 401 (k) accounts in the United States. It is therefore important to make sure that you keep track of old accounts when you change employers.
When it comes to managing your old 401 (k) account, there are several options available to you.
But before you start weighing the pros and cons, be sure to write down your 401 (k) account login details and change the account’s primary email address to your personal email address. This way, you won’t lose access to the account after you quit your job.
Then you should check with your former employer’s 401 (k) provider to see what their policies are for handling your account once you leave. You may have a specific time frame to make a decision, certain actions may not be an option in your plan, and there may be certain circumstances where you lose part of your 401 (k) balance if you haven’t stayed long enough. in your business so that it is fully acquired.
Once you understand the account management policies, you can now consider the best option for you.
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Keep it with your former employer’s plan
One of the simplest things you can do with your old 401 (k) account is to leave it where it is – it doesn’t require any further action on your part.
“Most companies allow you to do this so that your money continues to grow in the investment option you have selected. [when you first started work at that company]”said Jessica MacDonald, vice president of thought leadership at Loyalty. In addition, you will still be able to make withdrawals without penalty once you reach the age of 59 and a half.
However, keep in mind that if your account balance is less than $ 5,000, the account may be transferred to an IRA.
Another reason you may choose to keep your money in your former employer’s plan is that you really like the investment options it offered. Some employers may offer more access to certain types of 401 (k) investments, such as a wider range of mutual funds rather than just a target date fund.
However, there are a few potential drawbacks you should be aware of when deciding to go this route. For starters, you usually won’t be able to make additional contributions to this plan after you change jobs. Additionally, your former employer’s plan administrator may charge additional bookkeeping fees, administrative fees, and legal fees to continue managing the account.
Plus, you would have fewer withdrawal options if you were to leave your 401 (k) under your former employer’s plan. You may need to withdraw the entire balance even though you don’t need the full amount (partial withdrawals are usually not an option when you go this route). So let’s say the 401 (k) balance is $ 20,000 and you only want to withdraw $ 10,000 – you will end up having to withdraw the entire $ 20,000 even if you only need half of it. And, of course, you would be taxed on the amount and subject to a 10% penalty if you make the withdrawal before age 59 1/2.
And, you would be unable to take out a 401 (k) loan on your balance.
So if you are happy with the investments you made in your old 401 (k) plan, don’t worry if there are any additional charges and don’t really plan on making withdrawals in the near future. or until you reach retirement age, doing nothing with the account and leaving it to your former employer might sound appealing.
Roll it up in an IRA
Another option is to transfer your 401 (k) balance to a IRA. This could be an existing IRA that you previously opened or a new IRA. And, you can open it at any brokerage you want. (Select has identified the Fidelity Investments IRA as the best account for newbies. But if you need a little more advice, the Betterment IRA also gives you access to a robot-advisor who can help you with risk assessment and rebalancing).
Simply call the brokerage house where your IRA is located for a detailed rundown of the next steps to complete the rollover, and call your former 401 (k) provider to inquire about the process on their side. You may need to fill out forms with the details of the rollover, and you should ask if the check with the 401 (k) balance will be sent to you so that you can deposit it yourself or if it will be sent directly. to the brokerage house of your IRA.
Another advantage of the rollover option is that you will be able to make withdrawals without penalty for the purchase of a first home or for graduate fees, even if you are under 59 1/2. Of course, since this is a pre-tax account, you will still owe taxes on the amount you withdraw.
Transferring your plan to an IRA means you’ll have more control over the different ways you invest your balance – you won’t be limited to investing only in funds offered by your former employer. You will have thousands of investment options with many major brokerage firms, including mutual funds, index funds, and individual stocks.
Just be aware that once you reach age 72, you will need to make a minimum required distribution from a traditional IRA account, even if you are still working.
This option requires a bit more upstream work on your part, but in the long run, this path may offer you more flexibility, especially when it comes to your investment choices and potential withdrawals in the near future.
Transfer it to your new employer’s plan
You will need to check with your new employer to make sure they are accepting renewals from a previous job. But if you get the green light to do so, you will only be able to manage one 401 (k) account rather than two different accounts potentially from two different plan providers (or even more, depending on how many previous jobs you have. have occupied). had).
“Some people find that having a single 401 (k) account makes it easier to see all of their money in one place,” MacDonald explained.
Money will always have a chance to grow in your new employer’s plan – just make sure you like the new one. investment options available to you. And you will be able to save on all the additional costs of simply maintaining your balance with your former employer.
And unlike the IRA rollover option, you won’t have to take the required minimum distributions at age 72 if you transfer the money into your new employer’s 401 (k) plan.
“At the end of the day, it comes down to convenience,” MacDonald said. “And if you like to see all of your assets in one place, this option might make sense.”
And the last option, which is often discouraged, is to cash out your former employer’s 401 (k) account balance. By doing this, you will usually receive the money in the form of a check that will be mailed to you. However, there are serious disadvantages to doing this.
“Cashing in the 401 (k) is an absolute last resort because it has consequences,” MacDonald said. “If you do this before the age of 59 1/2 you will have to pay a 10% penalty and be subject to taxes.”
Fidelity actually illustrates the consequences of cashing out your 401 (k) with an example on their website. Suppose you have a balance of $ 50,000 in your 401 (k) account and decide to cash it out before the age of 59 1/2. The 10% early withdrawal penalty will be $ 5,000. Then, assuming a hypothetical tax rate of 7%, you will pay $ 3,500 in taxes. And finally, with a hypothetical federal marginal tax rate of 24%, you will still pay $ 12,000 in federal tax. This basically means that instead of cashing in and coming away with $ 50,000, you will actually be left with $ 29,500 after taxes and the 10% penalty fee. Plus, you’ll lose years of tax-free growth and compound interest on your investments.
The only circumstance in which you should cash your 401 (k) is if you are in dire need of cash and have no other options. But even then, you should consider a 0% APR personal loan or credit card before doing so. Otherwise, it is generally advisable to avoid withdrawals and consider one of the other three options above so that your money continues to grow on a tax deferral basis.
At the end of the line
Changing businesses can already be a hectic process – be sure to figure out what to do with your old 401 (k) account. The right choice will depend on your needs and whether or not you like the investment options offered by your former employer. However, the worst thing you can do is take a step back and ignore your 401 (k).
“The biggest mistake is not taking the time to assess your options,” MacDonald warned. “And another mistake is to take it in and not take an active role.”
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Editorial note: Any opinions, analysis, criticism or recommendations expressed in this article are the sole responsibility of the editorial staff of Select and have not been reviewed, endorsed or otherwise approved by any third party.