Got a New Job? Don’t Forget Your 401(k)!
You’ve finished the job hunt, got through the interviews, and landed the new job!
Many changes come with a new employer, and one of the most important changes to consider is what to do with the money in your 401(k) at your previous employer.
At least one move could lower your savings to almost half in tax and penalty payments.
Sign Up for Your New Employer’s Plan
Regardless of your existing 401(k) in your old plan, you should sign up for your new company’s plan as soon as you can.
Even if your new job has an automatic opt-in at 30, 60 or 90 days, you should be proactive and sign up as soon as you are allowed so you don’t miss those early months of contributions and matching funds.
Leave It Right Where It Is
If your vested 401(k) is more than $5,000, you can usually leave it the money in the existing retirement plan. This gives you some time to do your research for the eventual move.
If the balance in your old 401(k) is less than $5,000, your former employer could move your money into an IRA in your name, or they could send you a check for the total. A cash out could very likely have tax penalties, so you will want to avoid a cash out.
Some companies utilize auto portability. Your small balance would be automatically transferred to your new employer’s plan. Contact your old employer’s human resource department to find out if this is an option.
After you’ve been at your new job for a few months, you’ve had some time to research and ask questions about their plan. You can compare the new employer’s plan to the old looking at investment diversity and costs.
Lump Sum Distribution (or Cashing Out)
One option for taking your money out of a previous employers’ retirement plan, is to withdraw your money and deposit into a bank account (cash out). Resist the temptation to cash out.
Should you opt to have your 401(k) paid directly to you, the plan administrator will be required to withhold 20% for federal income taxes.
Distributions are taxed as ordinary income, so when you file your income taxes, you will have to pay the difference between the 20% already withheld and your tax bracket percentage. If you are in the 32% tax bracket ($85,526 to $163,300 taxable income bracket), you will actually owe a total of 32% on the cash out distributions.
Then, if you are younger than 59 1/2, you get a 10% penalty on your income taxes for early withdrawal from a retirement account.
For example, if you are younger than 59 1/2, and you cashed out a $100,000 401(k):
- $20,000 would be withheld for capital gains taxes before the money is transferred to you,
- and another $10,000 would be due on your income taxes as a penalty tax,
- and another $12,000 would be due on your income taxes because of your tax bracket,
- and you very possibly could owe additional state and local taxes.
Your actual cash from the $100,000 401(k) would be $58,000 or less.
There is an exception to the 10% early withdrawal penalty on 401(k) plans. If you separate from service during or after the year you reach age 55 or age for public safety employees of a state, or political subdivision of a state, in a governmental defined benefit plan, IRA, SIMPLE IRA, SEP, and SARSEP Plans do not qualify for this exception.
Roll It Over with a Direct Transfer to Your New Employer’s Plan
Another method is to roll over your old 401(k) plan in a direct transfer from the old to the new plan. Contact the 401(k) administrator at your previous employer to get all the forms you will need. Once you set up a direct transfer, you never get a check. Because the funds are not transferred to you, you avoid all the taxes and penalties associated with a cash out. Once moved to the new plan, your savings will continue to grow tax-deferred until you retire.
You should be aware that sometimes you cannot participate in a new employer’s plan until you’ve worked for them for a minimum period of time. An easy solution is to simply leave your money in the old employer’s plan until you are allowed to transfer to the new.
Roll It Over with a Direct Transfer to a Traditional or Roth IRA
Once you’ve researched the fund options available in your new employer’s plan, you may decide you aren’t happy with those choices, or you may discover that the new employer doesn’t offer a 401(k).
If either of these are the case, you can investigate a rollover IRA. There is a myriad of funds available, and you would have much more control over investments.
However, always make sure it’s a direct transfer of funds so you can avoid the taxes and penalties.
Tax Questions About Your 401(k) or IRA
If you have questions about your 401(k) or IRA rollover, please give us a call.