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AUGUST 02, 2018

Job change: Don't forget your 401(k)

Between the farewell party and cleaning out your desk, your 401(k) may be the furthest thing from your mind as you leave one job and start another. If that’s the case, you are in good company. About half the people who change jobs leave behind an employer-sponsored plan. What’s more, 20% have abandoned an account worth $50,000 or more, as reported in a study by ING Direct. 

It’s not hard to see why. The typical baby boomer held 12 jobs between the ages of 18 and 48, according to the U.S. Bureau of Labor Statistics. Today’s fast-paced workforce job hops even more. If you had a 401(k) plan with each employer, that’s dozens of retirement plans all over the place. The chances of things falling through the cracks are high.

If you’re about to change jobs, make a plan for your 401(k).

The case for doing nothing
Sometimes, leaving a 401(k) plan where it is can make a lot of sense. Your former employer might have a low-cost 401(k) plan with abundant investment options. That’s especially true if you are leaving a large employer. You might not be able to do better on your own.

Leaving a plan in place is also the simplest option. There are no administrative headaches to worry about to transfer your 401(k) elsewhere.

What’s more, a 401(k) also gives you an unlimited amount of creditor protection. Individual retirement accounts, on the other hand, only protect $1 million from creditors. Should you get sued, your 401(k) is off limits in a settlement, but only a portion of an IRA is. That could be an important consideration if you work in the medical field or another highly litigious profession.

Further, if you’re at least 55, you can make penalty-free withdrawals from a 401(k), though you will still need to pay income tax if you are taking withdrawals from a traditional 401(k). You must wait until age 59 ½ to make penalty-free withdrawals from an IRA, however.

Lastly, if you have employer stock in your 401(k), you will receive more favorable tax treatment if it’s distributed from a 401(k) instead of an IRA. It’s important that those funds not be transferred to an IRA or the benefit will disappear.

Combining forces
Another option is rolling over your old 401(k) into your new employer’s retirement plan, if your new company allows it. There are several advantages for this. 

For starters, it lets you keep your retirement assets all together, reducing the administrative headache of keeping tabs on multiple accounts. And your new company might have a better plan, with low fees and a well-diversified menu of investment choices, allowing you the option to upgrade your entire retirement nest egg.

Rolling into an IRA rollover
To simplify your financial life, you might think about consolidating all your retirement accounts under one roof in an IRA.

IRAs, which are held at a brokerage firm and overseen entirely by you, allow you an almost unlimited choice of investments. Even the best-designed employer plans have their limitations. With an IRA, you have access to a wide range of investments covering every investment style, including individual stocks. You can also invest your portfolio in alternative investments such as managed futures or commodities—investments you may want to better diversify your portfolio. 

Rolling all your retirement funds into an IRA allows you to keep all your retirement money in one plan and take a big picture view of your retirement savings.

And if you ever need to make a withdrawal, taking money out of an IRA involves much less paperwork than requesting a withdrawal from your 401(k) plan’s administrator.

An IRA rollover has drawbacks too. If you are using a backdoor strategy to make Roth contributions, a large portion of the conversion amount could be subject to income tax, if you have a rollover IRA with a sizable balance.

Don’t take the money and run
No matter what you decide to do with your 401(k), one option is rarely recommended: cashing out. Cashing out can be tempting, especially if money is tight, but it’s rarely a wise move. First, your employer will hold back 20% of your total to pay for federal taxes. On top of that, you must pay a 10% penalty if you are under 55. Say you cash out $50,000 from your 401(k), you will only receive only $35,000 after taxes and penalties.

But what’s even worse are the long-term consequences. You’ll lose out on the opportunity for compounded growth of your money on a tax-free basis, which has the potential to reduce your retirement savings significantly.

Watch your next move
The simplest way to handle moving money from your old 401(k) to another retirement account is by doing a direct rollover, so the funds are never in your control. If you direct your old company to write a check to you for the balance, you have 60 days to deposit it in a qualifying account in order to avoid taxes and penalties.

Unfortunately, mishaps are all too common and you might miss the window. There’s another complication: Your plan administrator will withhold 20% of your balance for taxes. If you want to avoid paying taxes on that 20%, you will need to make it up (and get reimbursed at a later date). As you can see, a direct rollover helps to avoid accidents and potentially big tax consequences.

In all the excitement of a job change, don’t forget your 401(k). With so many options about what to do next, one will surely fit your circumstances and goals.