Q&A: What Should I Do With My Old 401K?August 28, 2017
By Jere Smith, CFP®, CLU®, Financial Advisor at Point Wealth, LLC
We recently put out a request for our readers to ask us any questions they may have about their finances so that we can pinpoint the concerns that are relevant to today’s retirees. We are excited to introduce our new Q&A series that will address all of your questions. We hope it is helpful to you on your financial journey.
Our first question is a common one: what should I do with my 401(k)s from previous employers? It’s a relevant issue because many Americans change jobs frequently, sometimes more than eleven times throughout their career!
If the majority of your previous employers offered a 401(k), how can you keep track of your accounts when you move on to a new job? It’s a challenge to manage all of these accounts and simultaneously stay committed to a coherent investment strategy for your financial future. It’s not an easy task to track growth, manage fees, and stay diversified if your money is in multiple places. More than one-third of Americans have three or more retirement accounts. Is this you? What are your options when it comes to old 401(k)s?
1. Leave The Plan With Your Previous Employer
This is the easiest option because it doesn’t require you to do anything. However, it might not be an option for everyone. If your account holds less than $1,000, your employer is allowed to automatically cash out your account when you leave. If your account holds between $1,000 and $5,000, most companies will automatically roll your account into an IRA for you when you leave. Most people need to have over $5,000 in their account to have the option of leaving it in place.
There are a few benefits to leaving your money with your previous employer. If you turned 55 before leaving the job, then you can take penalty-free withdrawals before turning 59 ½. With the company plan, you may have lower priced or unique investment options that will no longer be available to you if you move the money.
Unfortunately, there are some downsides to leaving your money behind when you move on. You will no longer be able to contribute to your plan or take a loan from it. You are limited to the investment options the company offers, which may have higher fees or lower returns than you can find elsewhere. You are also limited in your withdrawal options. Instead of taking a partial withdrawal you may be forced to take the whole amount. If you like having your money in a 401(k), but don’t like your old company’s plan, there is another option.
2. Move Your 401(k) Funds Into Your New Employer’s Plan
Not all employers accept rollovers from other plans, so you will have to consult with your new plan administrator to see if this benefit is available to you. People often choose this approach as a way to consolidate assets into one account instead of having multiple small retirement accounts lying around.
3. Cash Out The Account
Although a 2012 report by Transamerica Center for Retirement Studies showed that 25% of unemployed or underemployed workers chose this route, it is almost never a good idea. Withdrawing the funds from your 401(k) account before you are 59 ½ obligates you to pay ordinary income taxes on them as well as a 10% early withdrawal penalty. For someone in the 25% federal income tax bracket paying 7% state income taxes, a $50,000 cash out would cost them $21,000 in penalties and taxes.
That means essentially forfeiting 42% of your money so that you can have it now instead of later. The only exception is for people who are 55 or older when they leave their job. They still have to pay income taxes on the money, but the penalty is waived. If you find yourself desperate for money, even a loan with 30% interest would be cheaper than cashing out your 401(k) account (if you are under 55).
4. Set Up Lifetime Income
The IRS allows you to take equal distributions of your account based on your life expectancy without facing the 10% penalty. In this way, you can turn your old 401(k) into lifetime income starting now or waiting until some point in the future. This is typically done using a product provided by an insurance company. You will still have to pay income taxes on the amount received, but this option is an alternative if you need the money sooner than retirement.
5. Rollover Your 401(k) Into An IRA
When considering what to do with their old 401(k) accounts, many people choose to roll them over into IRAs, or Individual Retirement Accounts. There are many advantages to having your money in an IRA as opposed to a 401(k) plan. You have much more flexibility with the IRA. You can shop around for low fees and reliable investment options. Instead of being tied to the 20 or so options your company offers, you can invest your IRA in just about anything except life insurance or collectibles. You can even invest your IRA in real estate that you manage through a self-directed IRA.
IRAs usually offer much greater flexibility as to who you can name as a beneficiary or contingent beneficiary of the account. You can opt for a self-directed IRA that has lower fees and requires your investment decisions, or you set up a brokerage IRA with your financial planner. Another option for your IRA would be to use an insurance product such as an annuity, which often comes with added features of guaranteed lifetime income and a guarantee of the principal balance.
When you roll all of your old 401(k) accounts into an IRA, you can keep adding money to the account, no matter who your employer is in the future. With all of your money in one place, it’s much easier to see the big picture of where you stand financially and manage your asset mix. The IRS even allows you to withdraw earnings penalty-free from your IRA before you turn 59 ½, as long as your account has been open for five years and the money is used for qualified expenses, such as buying your first home, higher education, or medical expenses.
You also have the option to convert to a Roth IRA, which could save you immensely on taxes in the long run and has even more permissive withdrawal rules and no required minimum distributions.
As always, it is a good idea to consult with an experienced financial professional when making changes to your retirement savings plan. A qualified professional can help you understand your options and how they relate to your particular situation, as well as walk you through the process. If you choose to stay invested in the stock market either through a 401(k) or a brokerage account, it would be wise to make use of a monitoring system such as WealthGuard™ or Assetlock™. Take a look at this video to see how these systems can help protect you from market downturns while still being able to capture market gains. If you want to talk about your 401(k) options, call Point Wealth Management in Wausau, WI at 715-870-2450.
About Jere Smith
Jere Smith is a financial advisor at Point Wealth Management, an independent financial planning and investment management firm. Serving individuals, families, and privately-owned businesses, he helps great people create great financial success through his services, including financial planning, retirement planning, estate planning, charitable giving strategies, and portfolio management. Along with nearly a decade of experience, he is a CERTIFIED FINANCIAL PLANNER™ professional and Chartered Life Underwriter, two of the most esteemed designations in the industry. He is passionate about education, whether it’s providing it to clients or adding to his own knowledge, and has written an article that appeared on FORTUNE.com. Based in Wausau, Wisconsin, Jere serves clients in multiple states. To learn more, visit http://pointwealthmanagement.com or connect with Jere on LinkedIn.
Investment Advisory Services offered through Retirement Wealth Advisors, (RWA) a Registered Investment Advisor. Point Wealth Management and RWA are not affiliated.