You spent years building your 401(k) balance, and then you moved to a new job and left your money in your old plan. Changing jobs can be a hassle, as you are likely busy putting your best foot forward for your new employer, negotiating salary, vacation or health care benefits, while possibly even learning a whole new company history.
If you have a balance of $5,000 or more, your former employer cannot force you to remove your funds from the plan. If your balance is between $1,000 and $4,999, however, your former employer can force you to roll your balance in to an IRA. In this instance, most plans work with a discount broker to help you establish the IRA. If your balance is less than $1,000, your former plan can send you a check. You should be aware that this is considered a distribution. The amount will be taxable and may carry the early withdrawal penalty.
Now consider your circumstances if you have changed jobs not once, but two or three times. You could easily have four different accounts with different balances, fees and investments all at different companies. This makes it difficult to view your portfolio as a whole, and can significantly increase the amount of financial paperwork you have to monitor.
As with many financial scenarios, the decision of what to do with your old 401(k) has many options, depending on your particular situation. Your three basic choices are to leave it where it is, roll your assets into another retirement plan, or take a cash distribution. With each of these options, you have several major points to consider: costs, investment choices, access, Roth options and perhaps treatment of company stock.
Costs of Staying
Generally, the lower the plan’s costs, the faster your money can grow. Many plans have administrative or management fees that are often based on the total assets in all employee accounts. If your former employer is small with less plan participants, you may be paying higher maintenance fees than you may elsewhere.
Investment Choices
Company 401(k) plans are limited on their investment options, but most have the basics: stock mutual funds, bond mutual funds and money market accounts. While investment diversity is a key element in asset growth, you do not need millions of choices to be properly diversified. When deciding what to do with your account, consider the investment choices available to you. If it is a small plan with few participants, carefully consider the fees associated with the investment vehicles available to you. Generally, these fees are in addition to any account maintenance fees you may be paying. Likewise, if you were considering rolling your old 401(k) into your new employer’s plan, you should compare both investment fees and maintenance fees.
Once you have weighed the fees, look closely at your investment options. Some plans have unique investment options that are exclusive to the plan manager. Some plans offer “stable value” options that pay a guaranteed percentage of annualized interest. If you are fortunate to have such a vehicle, be sure you could replicate your rate of return before you move your money.
Account Access
Generally, assets in retirement plans need to be left alone until you reach age 59½. However, in some 401(k) plans that age may be 55. If you were laid off at age 56, you may be able to take penalty-free withdrawals from your 401(k) if you need the money. If you transfer your assets to an IRA and need to withdraw before age 59½, you would have to pay a penalty for an early withdrawal, or consider substantially equal periodic payments, allowed under Section 72(t) of the Internal Revenue Code.
On the other hand, if you are a younger worker, you might benefit from transferring your old 401(k) into your new employer’s plan. In this scenario, you should be able to borrow against your account value and repay it, with interest, without incurring taxes or penalties.
Roth Options
If you are taking advantage of an IRA to Roth IRA conversion on a pre-existing IRA, you might choose to keep your assets in your former employer’s 401(k) plan. If you were to roll your 401(k) into an existing IRA that has both pre-tax and nondeductible contributions, rolling money from your 401(k) increases the percentage of the conversion that is taxable. Thus, when you completed the Roth conversion, you have more tax liability. Once the conversion is complete, you could then roll the old 401(k) into the IRA. In this situation, you maintain the advantage of tax-deferred compounded growth.
Treatment of Company Stock
Generally, you never want a cash distribution from a previous 401(k) plan, because you create regular income tax liability and possibly an early withdrawal penalty. However there are some unique circumstances when this should be considered, namely if you own shares of company stock that have greatly appreciated. We suggest that you consult your tax adviser to utilize the net unrealized appreciation rules for company stock. Essentially, you could transfer the stock to a taxable investment account and pay regular income tax on the stock’s basis. The appreciation that occurred while it was held in your former employer’s retirement plan should be taxed as long-term capital gain when eventually sold. This is a complex tax strategy, so seeking a C.P.A.’s advice is crucial.
Bottom Line
Regardless of where you decided to move your account, how you execute your decision is critical. Even if you are rolling your 401(k) balance into an IRA rollover—a relatively common choice—the rollover can become complicated if you receive a check from your former employer, triggering a taxable event. The check should be made payable to your IRA custodian or to your new employer’s plan in the benefit of your name. This ensures that you never take possession of the money. Subsequently, the funds will not be subject to an early withdrawal penalty or tax. However, some 401(k) plans do not allow this. Many large companies issue the check to the participant and mail the check to the participant’s address. In this case, you receive a distribution check from your former employer. You then have 60 days to show the 401(k) withdrawal was deposited to an IRA Rollover account. This is called an indirect rollover. If not completed properly, you can experience some unwanted tax consequences. We suggest working closely with a financial adviser or C.P.A. in such cases. Even with these complications, we still suggest using an IRA rollover because the entire account value is protected from creditors and lawsuits.
Your best option is to consult an expert and preferably one who can explain both the investment options and tax implications of your choices. If you have any questions on what treatment to give to your old 401(k) plan assets, you may contact Henssler Financial at 770-429-9166 or experts@henssler.com
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
