I Left My Job. What Options Do I Have With My Retirement Account?
When you leave your job, you have four (4) options to choose from with regards to your retirement account. Selecting the right option could help you avoid unforeseen tax consequences and save you money
Option 1 – Leave It Where It Is
The first option is the simplest: You can leave the account in your former employer’s plan. This applies in most cases unless the balance of your account is less than $5,000. If the balance of your account is between $1,000 and $5,000, your employer has options for removing it from the company plan, including cashing it out and sending you a check. If the balance of your account is greater than $5,000 then IRS rules stipulate that your employer is not permitted to cash out your account and must afford you the option of leaving it where it is.
However, the decision to leave the account in the company plan is more than a decision of convenience. Other factors to consider include: the investment options offered in the plan, the cost of the funds and administrative fees assessed to you, your withdrawal options, whether you need protection from creditors should you have significant debt, and whether the service and advice you receive on the assets are valuable to you.
Option 2 – Distribute The Money
The second option is to withdraw the money. This is a choice that is rarely taken because the tax consequences can be substantial, depending on the type of account you have and your age. But if you need cash and are in a hurry, it is an option nonetheless.
The amount you distribute from a traditional (pre-tax) retirement account is counted as earned income for tax purposes, so if your balance is sizeable, you could end up climbing into a higher tax bracket, which will increase the amount of taxes you pay for the year. Also, if you are under age 59 ½, a 10% tax penalty may apply to your distribution unless the reason for it is considered a hardship or you qualify for the “Rule of 55” provision. By comparison, the tax impact of a distribution from a Roth (post-tax) retirement account is more nuanced. Contributions to a Roth account can be withdrawn at any time tax-free, but if your account has been opened less than five (5) years and you are under age 59 ½, the earnings that are distributed will be subject to ordinary income taxes and a 10% penalty.
Finally, distributions from employer retirement plans are required by law to automatically withhold 20% for tax purposes and remit that amount to the IRS. For that reason, if you cash out, don’t expect to receive the full balance of your account.
Option 3 – Rollover The Balance To Your New Employer’s Retirement Plan
The third option you have is dependent on the rules of your new employer’s retirement plan. If your new employer’s plan accepts rollovers from other employer plans, you can complete paperwork to transfer the entire balance from your old account to the new one. This process is considered a direct transfer and will not result in any tax consequences to you, assuming you move the money to the same account type (pre-tax to pre-tax or post-tax to post-tax).
This option is attractive if the investment choices and administrative fees of your new employer’s plan are better than those offered in your former employer’s plan or what is available to you in an IRA. Moreover, keeping the money in an employer plan provides you the strongest protection from creditors if you have significant debt. According to the credit reporting agency, Equifax, there is no protection cap on accounts that are ERISA-qualified, whereas creditor protection on IRA accounts is capped at $1.0M under BAPCPA. Keep in mind that some employers do not allow new employees to participate in their retirement plan for 90 days, so if you want to roll over your old account into your new employer’s plan, you may have to wait until you are eligible.
Option 4 – Rollover The Balance To An IRA
The fourth option is to roll over the balance of your account to an IRA. This option gives you the greatest amount of control over your money. When you transfer the funds to an IRA, you can choose how the money is invested. You can manage it yourself or you can hire an advisor to help you select and manage the investments for you.
This option is beneficial in cases where your employer’s plan has limited investment choices and/or the choices offered are more expensive than other alternatives. Not only can the investment choices have higher expenses than those in an IRA, but employer plans have administrative fees that can be significant depending on how much is invested in the plan overall. Additionally, if you need to withdrawal some of the money from your account, IRAs are not subject to the automatic 20% tax withholding that employer accounts are. In IRA accounts, you have the flexibility to determine the appropriate withholding amount based on your specific tax situation.
After you separate from your employer, you have options with your retirement account that should be reviewed to determine which one is best for you. A review of your options and your overall financial situation might reveal additional opportunities that could help you pursue financial success. If you are interested in learning more about how a financial plan can benefit you, please contact us today.