Dear Carrie, I just accepted a new position. All my retirement money is in a traditional 401(k) with my current employer. What should I do with it now that I’m leaving? –A Reader
Dear Reader, I get this question often, and it’s no wonder. According to a 2016 LinkedIn study, over the past 20 years, the number of companies people worked for in the five years after they graduated from college has nearly doubled. Those who graduated between 2006 and 2010 have averaged almost 3 job changes during that five-year period alone.
Changing jobs can mean new opportunities and often an increased salary, but it also can impact your retirement savings, so I’m always happy to address this question.
The great thing about a 401(k) is that you can take the money with you when you change jobs. But you do have some important choices to make that will depend on where you are in life and your future plans. So let’s talk about your options and reasons why you might make a particular choice.
Leaving a 401(k) with a former employer is the easy route
Sometimes in the flurry of a job change, it just seems easier to leave your retirement money where it is. The drawback here is that many employer-sponsored plans have limited investment choices. Even if you’ve been happy with your 401(k) returns so far, rolling it over into another company plan or an IRA could give you different and potentially greater opportunities to grow your money.
Consider, too, that if you leave your money at your old job and then end up having multiple 401(k)s, what initially seemed like an easy choice could become a management challenge.
Rolling over to a new employer’s 401(k) makes sense if you plan to stay
Moving your retirement savings to your new employer’s plan could be the sensible option, especially if you expect to be in your new position for a long period of time.
First, make certain your new employer’s plan accepts rollover contributions. Then, check out what’s offered. Compare the features, costs and investment options of the new plan to what you currently have.
If you’re lucky enough to have the choice of both a traditional and a Roth 401(k), there are a couple of other things to consider. For instance, you could roll over your current 401(k) into the new traditional plan. (You can’t rollover a traditional 401(k) into a Roth 401(k).) But you don’t have to stop there. You could also open a Roth 401(k) at your new job and make future contributions to that plan or even split contributions between the two.
The beauty of this is tax diversification down the road. When you start to make withdrawals, you’ll pay ordinary income taxes on the traditional 401(k) disbursements, but money you take from the Roth 401(k) will be tax-free.
If you think you’ll switch jobs again, a Rollover IRA could be more practical
As the LinkedIn study I mentioned reports, people tend to change jobs often these days. If you think this might be your situation, you might consider rolling over your 401(k) assets into an IRA. This can provide a wider range of investment choices and you won’t have to worry about moving your money each time you changed jobs. (One caveat: if you’re not an experienced investor, I highly recommend seeking the advice of a trusted portfolio advisor.)
Rolling a traditional 401(k) into a traditional IRA is generally the easiest. You do have the choice of rolling your current plan into a Roth IRA where you would have the benefit of tax-free withdrawals once you’ve turned age 59 1/2 or older and the account has been in existence at least five years. You would, however, have to pay ordinary income taxes upfront on any assets you rollover.
Taking the cash will cost you
You should generally avoid even thinking about taking the cash unless you’re in dire economic straits. First, you’ll pay ordinary income taxes on the entire amount. Plus, with a few exceptions, you’d pay a 10 percent early withdrawal penalty if you were under 59 1/2. Even more worrisome, you’d have to start over on your retirement savings.
Be sure to do a direct rollover
Whatever you choose, have the money rolled over directly from your old employer to either the new employer or to the financial institution to avoid tax and timing issues. If you’re rolling over to your new employer’s plan, contact the new plan’s administrator to set up a direct rollover. If you’re rolling over to an IRA, your financial institution will often handle the details for you. This is important because if your 401(k) assets are distributed to you personally, 20 percent will automatically be withheld. You then have 60 days to put the money into another tax-advantaged retirement plan or else it’s considered a distribution and full taxes and penalties apply.
Carefully consider all of your options
Each option has its own benefits and limitations. Prior to making a decision, be sure to consider such factors as differences in investment related expenses, plan or account fees, available investment options, distribution options, legal and creditor protections, the availability of loan provisions, tax treatment, and other concerns specific to your individual circumstances.
One other consideration: If you have appreciated company stock in your plan, you might want to talk to your financial advisor about how to transfer that stock to a taxable account and potentially save on capital gains taxes.
You can find more information on your options at www.schwab.com/rolloveroptions.
There’s a lot to think about, but it’s well worth the effort. Making smart choices now will mean a more secure financial future. Best of luck in your new job.
Carrie Schwab-Pomerantz, CERTIFIED FINANCIAL PLANNER ™ is president of the Charles Schwab Foundation and author of “It Pays to Talk.” You can e-mail Carrie at askcarrie@schwab. com.