Your 401(k) and Job Transitions: How to Handle a 401K Rollover the Right Way
Switching careers or facing a job loss often raises the question: Should you rollover your existing 401(k)? In my experience, unfortunate outcomes generally arise from three pitfalls: Misguided Counsel, Lack of Guidance, and Disregarding Sound Advice. Here are the essential things you should be aware of.
What Are You Eligible For?
When you part ways with your employer, willingly or otherwise, you're entitled to access your vested balance. This will always encompass your personal contributions (pre-tax, after-tax, or Roth), and usually any returns you’ve gained on those funds. Employer contributions may be included but are often subject to a vesting schedule. Typically, you should be fully vested in your employer's contributions after three years of service. Always check with your plan administrator or consult your Summary Plan Description to understand your vesting status.
Roll It, Don’t Spend It!
If you opt for a payout, you'll be subject to taxation at your current income tax rate, apart from any after-tax or Roth contributions you've made. Moreover, an additional 10% IRS penalty is likely if you're under 59 1/2 years old. If your vested balance exceeds $5,000, you have the option to leave your money in your previous employer’s 401(k) until normal retirement age. You're also allowed to do a direct rollover to an IRA or another employer’s 401(k).
Execute It Flawlessly—Seek Professional Help
Make sure you work with a professional who understands all of the rules pertaining to rollovers. I have seen rollover errors that will make you cringe. One of these errors was no advice given by a banker, which resulted in a $50,000 taxable distribution and a 10% penalty for early distribution…just days before the guy turned 59 1/2 !! You could blame the bank, but isn't the account holder responsible for not contacting a qualified retirement or tax professional to assist and consult on this distribution? Luckily for him, we happened to be reviewing his accounts within the 60-day window of the distribution and we were able to help him correct it…but that was a HUGE mistake!
Should I roll over to my new 401(k) plan or to an IRA?
Assuming both options are available to you, there is no right or wrong answer. Make the decision based on your own needs and priorities. It is best to have a professional assist you with this since your decision could have significant consequences…like my previous example!
Advantages of Opting for an IRA Rollover:
- Expansive Investment Landscape: IRAs usually offer a broader spectrum of investment options, providing an opportunity for more tailored asset allocation.
- Custodial Flexibility: In an IRA, clients have the ease of switching between custodians, facilitating better control over investment strategies and costs.
- Tailored Distribution Plans: Depending on the specific IRA, you may have more flexibility in structuring withdrawals to align with your financial goals and tax planning.
Considerations for a New 401(k) Rollover:
- Loan Features: Many employer-sponsored 401(k) plans offer loan provisions, allowing clients a measure of liquidity without triggering a taxable event.
- Robust Creditor Safeguards: Generally, 401(k) plans provide more comprehensive protection against creditor actions, which can be a crucial consideration for some.
- Certain qualified plans permit participants older than 73 to delay their Required Minimum Distributions (RMDs) until retirement. Confirm eligibility for this option with your employer for potential tax advantages..
Each rollover option comes with its own set of advantages tailored to different financial situations and goals. It's always recommended to consult with a knowledgeable advisor to make the most informed decision.
What about outstanding plan loans?
In general, if you have an outstanding loan, you'll need to pay it back, or the outstanding balance will be taxed as ordinary income. If you can't pay back the loan before you leave, you'll have 60 days to roll over the amount that's been treated as a distribution to your IRA. Of course, you will have to have the funds to be able to do this.
The decision of what to do with your 401(k) when changing jobs should not be taken lightly. Consult a professional to navigate this complex landscape—it could save you a significant amount in taxes and penalties.
Krista McBeath is an Investment Advisor, Chartered Financial Consultant, a Licensed Insurance Advisor, a Fiduciary, and an experienced tax advisor who specializes in financial planning, investments, and insurance.
She utilizes advanced tools for in-depth calculations that analyze tax and retirement scenarios to help her clients avoid a future tax time-bomb. Whether this means enjoying more of your hard-earned money in retirement or passing along assets to loved ones with less tax burden, planning makes the difference.
Her new book, The Generational Wealth System outlines a holistic approach to preserving lifestyle, wealth and legacy.