One of the common threads of a mobile workforce is that many individuals who leave their job are faced with a decision about what to do with their 401(k) account. Keep in mind, distributions from 401(k) plans and most other employer-sponsored retirement plans are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 70½, you must begin taking required minimum distributions. So essentially individuals have three basic options with the 401(k) account they accrued at a previous employer.
Option 1: Leave It with Your Previous Employer
You may choose to do nothing and leave your account in your previous employer’s 401(k) plan. However, if your account balance is under a certain amount, be aware that your ex-employer may elect to distribute the funds to you. While inertia is one of the primary reasons for not moving a 401(k), there may be reasons to keep it there — such as investments that are low cost or have limited availability outside of the plan. Other reasons are to maintain certain creditor protections that are unique to qualified retirement plans, or to retain the ability to borrow from it, if the plan allows for such loans to ex-employees.
A 401(k) loan not paid is deemed a distribution, subject to income taxes and a 10% tax penalty if the account owner is under 59½. If the account owner switches jobs or gets laid off, any outstanding 401(k) loan balance becomes due by the time the person files his or her federal tax return. Prior to the 2017 Tax Cuts and Jobs Act, employees typically had to repay loans within 60 days of departure or face potential tax consequences.
The primary downside is that individuals can become disconnected from the old account and pay less attention to the ongoing management of its investments.
Option 2: Transfer to Your New Employer’s 401(k) Plan
Provided your current employer’s 401(k) accepts the transfer of assets from a pre-existing 401(k), you may want to consider moving these assets to your new plan. The primary benefits to transferring are the convenience of consolidating your assets, retaining their strong creditor protections, and keeping them accessible via the plan’s loan feature. Provided their new plan has a competitive investment menu, many individuals prefer to transfer their account and make a full break with their former employer.
Option 3: Roll Over Assets to a Traditional Individual Retirement Account (IRA)
The last option is to roll assets over into a new or existing traditional IRA. Again, keep in mind that withdrawals from traditional IRAs are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 70½, you must begin taking required minimum distributions. A traditional IRA may provide a wider range of investment choices than what may exist in your new 401(k) plan. The drawback to this approach may be less creditor protection and the loss of access to these funds via a 401(k) loan feature. Remember, don’t feel rushed into making a decision. You have time to consider your choices and may want to seek professional guidance to answer any questions you may have.