January 29th, 2016
Larry Light – Contributor
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People change jobs. But what should they do with the retirement account from the previous employer? Barry Glassman, CFP, the founder and president of Glassman Wealth Services in Reston, Va., has some solid advice on this important subject:
It’s a question my clients ask me all the time: “What should I do with my old 401(k)?” When you change jobs, you can keep your 401(k) where it is, or roll it to other accounts.
Let’s examine your choices:
Roll your 401(k) to an individual retirement account is usually the default option I recommend to clients. Flexibility is the primary reason.
Many 401(k) plans have limited mutual fund options, and those funds, often times, have higher management fees than IRAs. You can open an IRA at many custodians such as Charles Schwab, Fidelity and Vanguard, and have virtually unlimited investment options.
You can simplify with low-cost index funds, invest in active mutual funds or exchange-traded funds, or even pick individual stocks for your portfolio.
Roll your old 401(k) to the new 401(k) if you’re happy with your new employer’s plan and options. Consult with your new human resource department to confirm that rollovers are permissible. Keeping all your retirement assets in one account makes it easier to manage.
Keep your 401(k) with your former employer if it is a terrific plan with lots of investment options. But some previous employers may charge you extra administrative fees, which can eat into your overall return.
Now you know your options. But before making your rollover decision, take these factors into account to avoid mistakes that could result in higher taxes, penalties and fees.
1. Your age. Once you turn 70½, you must begin withdrawals from a traditional IRA, even if you don’t retire. Your 401(k) is not subject to this rule as long as you continue to work. So if you’re over 70½ and still working, a 401(k) is advantageous in reducing your taxable income.
2. Company stock. If you roll company from a 401(k) stock to an IRA, the entire gain is taxed at your ordinary income tax rate when you withdraw it.
However, if you have a triggering event, like turning 59½ or losing your job, you can move the company stock to a taxable account, and roll the rest of the account into an IRA. You must pay ordinary income tax on the basis of the stock upon transfer, but the growth over the basis (the net unrealized appreciation) is taxed at the more favorable capital gains rate only when you sell the stock.
3. Roth option. If you have a pre-tax 401(k) and a Roth 401(k), it’s important to keep those dollars segregated when rolling over to IRAs. Make sure you establish two accounts: a traditional IRA for the tax-deferred 401(k) dollars and a Roth IRA account for the Roth 401(k).
4. Creditor protection. In some states, 401k plans offer better creditor protection than IRAs. So if debt is a concern, you may want to keep the funds where they are.
5. Don’t take the easy way out. Probably the biggest mistake you can make when leaving a job is cashing out your old 401(k). Often times, people, especially younger employees, see their retirement dollars as a windfall to spend. They leave a company and cash out whatever dollars they saved in their retirement accounts. Not only does this create taxable income and a 10% penalty, but puts them behind in their retirement savings. It’s difficult to make up that savings deficit as people get older.
Leaving a job, whether retiring or just moving to the next opportunity, can be a hectic and scary time. Relax, keep things simple and work with your financial advisor to decide what makes the most sense for you and your retirement.