(Robin Hartill, CFP®)
Quitting a job has never been more popular. In 2021, workers left their jobs at the tune of nearly 4 million per month, the highest rate ever recorded by the US Bureau of Labor Statistics. And a survey of nearly 10,000 workers conducted by risk management and advisory company WTW in late 2021 and early 2022 found that 53% of US employees were open to leaving their employers.
If you’re joining the Great Resignation, you may need to figure out what to do with the money in your old employer’s 401(k) plan. Here are your four basic options.
1. Leave it in your old 401(k)
You could leave your money in your old employer’s 401(k) if you’re happy with your investment choices and the fees are low, provided that the plan rules allow it. Your money stays invested, so earnings will still accrue. But you won’t be able to contribute additional funds, so it’s important that you open a new retirement account — like an individual retirement account (IRA), a 401(k) with your new employer, or a self-employed retirement plan –to continue saving.
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However, many employers will only allow you to stay in their plan if your balance is above $5,000. If your account has between $1,000 and $5,000, your old employer can create an IRA for you and roll over the money on your behalf. Your old employer has to give you ample warning before doing so. The money will be invested in superconservative investments, like money market funds or certificates of deposits (CDs). After account fees, you may actually earn negative returns.
If your balance is less than $1,000, your plan can simply cut you a check. When that happens, the plan is required by the IRS to automatically withhold 20% of the balance.
The bottom line: Be sure you understand the rules for your old employer’s plan, particularly when your balance is less than $5,000.
2. Roll it into an IRA
Another option for your old 401(k) is to roll it over into an IRA. The advantage of doing so is that you can invest your money in virtually whatever stocks, bonds, mutual funds, and exchange-traded funds (ETFs) you choose.
You’ll generally avoid taxes and penalties in doing so — unless you’re rolling over a traditional 401(k) account into a Roth IRA. In that event, you’d owe income taxes on the amount you roll over.
Aim for a direct rollover, which is where your plan administrator sends the money directly to your IRA provider. If your old plan sends you a check, 20% of your balance will be automatically withheld, per IRS rules. But you’ll have to deposit the entire balance to avoid penalties.
In other words, if you have a $50,000 balance and your plan sends the money straight to you, you’ll receive $40,000. But you’ll still need to deposit $50,000 into an IRA or a different retirement plan to avoid hefty taxes and fees.
3. Roll it over to a new 401(k)
Another option is to roll over your 401(k) into your new employer’s retirement plan, assuming the plan allows it. You’ll want to examine the fees and investment options to be sure they’re satisfactory. Otherwise, rolling the balance into an IRA or keeping it with your old employer are better options.
As with rolling the balance into an IRA, always ask for a direct rollover. In this case, you’d want your old plan to send the money directly to your new 401(k) provider. Otherwise, you could face a month of mandatory withholding, taxes, and ends.
4. Cash it out
Cashing out your 401(k) is almost always the worst option when you quit your job. Your balance will be subject to the mandatory 20% withholding, plus you’ll owe a 10% early withdrawal penalty if you’re younger than 55. (Typically, the 10% penalty applies if you withdraw retirement funds before you’re 59 1 /2, but the IRS makes an exception for workers 55 and up who leave their job for any reason.) If the 20% withholding doesn’t cover your tax bill, you could even owe more money come April 15.
An early 401(k) withdrawal is extremely costly. If your marginal tax rate is 22% and you cash out a $50,000 balance, you’d receive just $32,500 after taxes and ends.
But the cost is even more jaw-dropping when you factor in lost gains. Let’s assume you earn 8% annual returns and cash out 10 years before your planned retirement. That $50,000 balance would have been worth more than $107,000 had you never contributed another cent. And remember: You received just $32,500 on your withdrawal.
Keeping your 401(k) money invested in your old plan or rolling over the balance into an IRA or a new plan can all be good options. But cashing out your 401(k) early is almost never worth the cost.
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