What To Do With An Old 401(k) or 403(b) From a Previous Employer

Forget Something? Maybe An Old 401(k)

Explore your options to make an informed decision regarding your previous employer’s retirement accounts

In January 2018, the Bureau of Labor Statistics {BLS} reported that the median employee tenure was 4.3 years for men and 4.0 years for women. So the average employee stays at a job typically less than five years, and according to BLS, people have about 12 different employers throughout their working lifetime. In these natural transitions, many people find themselves wondering what to do with a 401(k) (or another type of retirement account) from a previous employer. Moreover, there are those who have multiple 401(k) accounts drifting out there from several former employers. It's essential to understand your options so you can make an informed decision to help you make the most of your financial future.

For those who have 401(k) account(s) left behind, most likely you have little control of it right now because where it's located, it is subject to that company's specific 401(k) rules, guidelines, and investment options. You may not be paying very close attention to how it's performing or know if there's possible room for improvement. 401(k) plans have a limited lineup of investments chosen by the plan administrator. How your old 401(k) was set up may have been with the intention that it was a good fit for a large, varying group of employees and it's not likely a plan tailored to your specific financial needs or goals.

To take control of your financial future, it's essential to take some time to consider the options available to you if your goal is to get the most out of your hard earned savings. Consider the pros and cons of the methods below to help you determine which may be a good fit for you.

1. Distribute and Keep the Cash from the 401(k). Unless you are dealing with the unfortunate event of a severe financial setback where you need the funds immediately, there's an excellent chance you're going to want to avoid this option. Those who choose this decision can be subject to losing 20%+ of their funds due to federal (and state) income taxes on the taxable portion of the amount distributed, and a 10% penalty for early withdrawal may apply if you are under age 55 when you retire or terminate service. (penalty exceptions may apply, and how much you “donate” to the IRS is dependent on your tax bracket and age). If your plan's balance is under $5,000 currently, you may have to collect a check from them as low balances can be subject to forced cash out when you leave employment. When this takes place, the company will follow an IRS mandatory withholding procedure, which assesses a 20% tax on the 401(k) balance. A mandatory withholding happens whether you may actually owe money or not and regardless of the size of the balance. There is a possibility of receiving the 20% back (or some of it back) in a tax refund, but this depends on each person's specific tax circumstance. Keep in mind that you will lose the opportunity cost and purchasing power on that 20% until tax season with these IRS withholding guidelines, which may not allow you to make the best use of your financial resources. When I ask people in introductory financial planning meetings what their biggest financial mistake they ever made was, cashing out an old retirement plan comes up as a common regret.

2. Transfer Assets to a New Employer's Retirement Plan. For someone who is younger, with a long work time horizon, and who do not want to have to juggle multiple accounts, this could be ideal. Transferring your old 401(k) to the new employer's plan may also be a right choice for those who feel as though retirement is too far off to put much thought into and are not ready to work with a financial planner. Consolidating your old plan with your new one can be a strategic approach to help simplify your financial life. Unlike the Cash Out distribution outlined in option 1, a transfer allows you to avoid the mandatory 20% tax withholding and potential early withdrawal penalties on distributions, and you will defer income taxes on your assets until you make withdrawals from your new employer’s plan. (assuming paperwork is correctly completed). As with the next option, you may have limited investment choices. It’s a good idea to review the investment options for both plans to determine if you think the transfer will likely provide advantageous options given your goals and risk tolerance.

3. Leave Assets in Previous Employer's Plan. When the plan allows and you meet current governmental limits to do so, sometimes you may think it best to leave your assets in the old 401(k). In some cases, while investment options are limited, there may be securities in that 401(k) plan that happen to be what you want to help you pursue your retirement savings goal to be able to make the jump at a specific age—and that’s great. Of course, it is still essential to carefully consider all your current options, especially if you happen to find a unique opportunity that works well for you. It may also be advantageous to call your old HR department to determine if added administration or participant fees have been shifted to you as this can be the case in some plans when you no longer work at the employer.

4. Move Assets to an IRA via Direct Rollover or Transfer. People likely choose this option to gain more control, investment flexibility, and professional oversight. However, there are benefits found in a 401(k) that are not available with an IRA, and fees may be higher. Having a financial planner help you determine what rate of return you are looking for and how much risk you should be taking, given your unique goals and financial situation, can also provide you with confidence using this approach to plan for your financial future. Directly transferring your distribution to an IRA also allows you to avoid the mandatory 20% tax withholding and potential early withdrawal penalties, and you will defer income taxes on the distribution until you make withdrawals from the IRA. You may also be able to converting a pre-tax retirement account to a ROTH IRA, but this can be a very complex strategy to consider with many factors to evaluate. A financial professional should be sought out when considering this to help avoid any unnecessary tax surprises or other unfortunate errors. You can choose to rollover your 401(k) to an IRA on your own, or with the help of a financial advisor.

There is no rule of thumb when it comes to making this decision. Your choice will ultimately come down to your personal needs and financial situation. It is vital to do your due diligence to find out which of these options could offer you the most economic freedom and a long-term plan to help you make the most of your funds.

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EARLY WITHDRAWAL PENALTY — Assets distributed in cash from a retirement plan before reaching age 59½ may incur a 10% penalty, unless an exception applies.

PENALTY EXCEPTION — The IRS will waive the 10% early withdrawal penalty if the distribution qualifies for one of the multiple exceptions allowed by current regulations.

TAX DEFERRED — Growth and earnings are not taxed until withdrawn from the retirement plan account.

DIRECT TRANSFER — Transfer of eligible plan assets to another qualified retirement account such as a new employer’s plan or an IRA. The investor does not take physical custody of the plan assets.

ROLLOVER — The investor receives a check for the retirement plan assets and deposits the proceeds into a rollover IRA account within 60 days from date of distribution.

This is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.

This information does not constitute tax or legal advice. Please contact your tax and legal advisor about your particular situation.  05/20

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