If you've lost your job or are changing jobs, you may be wondering what to do with your 401(k). It is important to understand your options. I've seen situations that I consider to be “horror stories.” These stories stem from three risks: Bad Advice, No Advice, and Ignoring Good Advice. Here are some basics that you need to understand.

What will you be entitled to?

If you leave your job, either voluntarily or involuntarily, you'll be entitled to a distribution of your vested balance. Your vested balance will always include your own contributions (pretax, after-tax or Roth) and typically any investment earnings you may have on those contributions. It will also likely include any employer contributions, but these contributions could be subject to a vesting schedule. In general, you must be 100% vested in your employer's contributions after 3 years of service, or you must vest gradually becoming fully vested after 6 years. Many plans will have immediate vesting so check with your plan administrator or reference your Summary Plan Description to find out how your particular plan works. This is very important for you to understand as you may forfeit employer contributions if you are not fully vested.

Don't spend it, roll it!

If you take a distribution you'll be taxed at your ordinary income tax rate on the entire distribution; except for any after-tax or Roth contributions. In addition, if you are under age 59 1/2, an additional 10% IRS penalty will likely apply to the distribution (there are a few exceptions). If your vested balance is more than $5,000, you can leave your money in the employer's plan until you reach normal retirement age. But your employer must also allow you to make a direct rollover to an IRA or to another employer's 401(k) plan.

But PLEASE make sure you do it right!

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 !! Honestly, it's not the bank's fault. t is the account holders fault for not contacting a qualified retirement or tax professional to assist and consult on this distribution. Luckily for him, we prepared his taxes and caught this. He was still within a 60-day window of that 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!

Reasons to roll over to an IRA:
  • Most professionals will recommend this option because you have more investment choices with an IRA than you do with your employer plan. You also can move your money more freely around various investments in an IRA whereas an employer plan typically gives you a pretty limited menu of investments (typically mutual funds) to choose from.
  • You can allocate your IRA dollars among various IRA custodians. Because you can complete an unlimited number of trustee-to-trustee transfers in a year, you can change trustees as often as you like if you are unhappy with your investment performance or would like more diversification options. With an employer plan, you can't move your money to a different trustee.
  • An IRA may give you more flexibility with distributions compared to distribution options in a 401(k) depending on the rules of that particular plan.
Reasons to roll over to your new employer's plan:
  • Many employer plans have loan provisions. If you roll over into a plan that permits loans, you may be able to borrow up to 50% of the amount that you rolled over. In contrast, you can't borrow from your IRA- you can only access the money by taking a distribution which may be subject to tax and penalty.
  • An employer 401(k) plan may offer greater creditor protection. Most 401(k) plans receive unlimited protection from creditors under federal law. In most cases, your creditors can't attach to your plan funds, regardless of whether or not you've declared bankruptcy. In contrast, funds that you roll over into an IRA are generally protected under federal law only if you declare bankruptcy.
  • You may be able to postpone required minimum distributions. For IRA's, these distributions must begin by April 1 of the year following the year you turn 70 1/2. (This is a conversation for another day) However, if you work past 70 1/2 and are still participating in your company plan, you can delay your first distribution until April 1 following the year of your retirement.
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.

In summary, there are a lot of factors to consider when making this decision.  Please contact a professional for help!  It could save you thousands of dollars in taxes and penalties.


1 thought on “Rollover Options When Changing Jobs: Take Your 401(k) and…Roll It!

  1. Pingback: The Retirement Decision: Key Considerations - McBeath Financial Group

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