If you’ve recently changed jobs or are sitting on an old 401k from a previous employer, one of the most important decisions you must make is what to do with your old retirement accounts. This retirement account can be a significant asset to grow tax-deferred, and there are several ways to manage it when leaving an employer. In this article, we will discuss four main options for 401ks: keeping it with the old employer, rolling over the money into an IRA, rolling it over into a new employer’s plan, or cashing out. We’ll look at each option in detail so that investors can understand their choices and make an informed decision about how best to handle their 401k retirement accounts.
- Traditional 401k plans
- Safe harbor 401k plans
- SIMPLE 401k plans
The 401k plan is an advantageous way for employees to save for their future, allowing them to electively defer a portion of their wages without incurring federal income tax withholding. It’s worth considering the various types of plans that support these contributions so you can find one best suited to your needs: traditional 401k, safe harbor 401ks, or Simple 401k are all possibilities.
Traditional 401k plans
With a traditional 401k plan, employees have the opportunity to benefit from pre-tax elective deferrals through payroll deductions. Employers can then choose to make generous contributions on behalf of their participants or provide matching contribution options based on an employee’s withholdings. Depending on the terms laid out in your organization’s vesting schedule, it may take some time for employers’ contributions to become nonforfeitable and vested by employees – though they could also be immediately vested depending upon policy mandates established within your company.
Employers must conduct annual tests to guarantee 401k plans meet nondiscrimination standards – these are known as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP). By doing so, employers can ensure that wage deferments and matching contributions remain fair for both highly-compensated employees and others.
Safe harbor 401k plans
Safe harbor 401k plans offer guaranteed to vest employer contributions when made. This type of plan avoids the restrictions and annual nondiscrimination tests normally associated with traditional 401k plans. Additionally, such plans are exempt from top-heavy rules that apply to other accounts under Internal Revenue Code 416 if no additional contributions are made in any given year. Revenue Code 416 states “a 1-percent owner of the employer having an annual compensation from the employer of more than $150,000”.
Both the traditional and safe harbor plans are for employers of any size and can be combined with other retirement plans.
SIMPLE 401k plans
Employers with 100 or fewer employees and $5,000 in compensation for the preceding calendar year can provide retirement benefits to their staff through a SIMPLE 401k plan. Unlike traditional plans that require annual nondiscrimination tests, this cost-effective option mandates employer contributions that are fully vested to eligible participants who cannot receive any other type of benefit from another source within the organization.
Keeping Your 401k With Your Old Employer: Pros and Cons
Keeping with your old employer: Pros
- Avoid a 10% penalty for withdrawals/potential transfer fees
- Tax break when owning company stock – Net Unrealized Appreciation
- Options for loan financing on old 401k plan
Retirement funds are a critical component of financial security, and 401ks can be an effective way to save for the future. One option is to keep your 401k with the old employer, but there are pros and cons to this choice. The primary benefit of keeping a 401k with an old employer is that you may be able to keep account fees low.
Many employers who offer 401k plans also offer reduced fees within their own plans. If you have access to employer contributions or matching funds in your 401k plan with the old employer, you will not lose out on those benefits by maintaining your account there.
Keeping with your old employer: Cons
- Unused accounts can accumulate and become a digital burden
- Not all employers may grant you the ability to take your retirement plan with you
- Lack of access to account changes like management and administrative fees
- Withdrawing funds can sometimes be tricky
There are some drawbacks to keeping a 401k with an old employer as well. While it may have lower fees than other options and provide potential additional savings through employer contributions, it does limit overall investment choices – depending on the plan’s offerings – as well as cut down on liquidity because you cannot pull out assets from the account without penalty until age 59 ½.
Having old 401k spread over different companies and investment agencies with limited options can be burdensome and time-consuming to manage and keep track. This can leave individuals at risk of having too much exposure in only one asset class or sector and missing out on potential growth opportunities available through diversification across many asset classes or sectors offered in other 401k plans or IRA options.
Rolling Your 401k Over Into an IRA
401k into IRA: Pros
- IRA advantages: such as access to various investment possibilities and optimization strategies that can help you minimize taxes (Roth conversions and backdoor Roth IRAs)
- Safeguard yourself from penalties and fines from IRS
- No taxes on transfer funds
401k into IRA: Cons
- Paperwork (make it easier with a Financial Advisor)
- Possible higher fees
- Typically can’t withdraw penalty free from IRA till 59 ½
- IRA required minimum distributions (RMDs), If you work past age 72, 401ks generally do not require RMDs.
Rolling your 401k over into an IRA can be an effective way to manage your retirement savings. An IRA, or individual retirement account, is a special type of investment account designed to help individuals save for retirement while providing them with tax advantages. Rolling over your 401k into an IRA allows individuals to choose from a wider range of investments and gives them more control when it comes to managing their retirement funds.
When rolling a 401k over into an IRA, investors will first want to compare the fees associated with their 401 k plan versus the fees charged by various IRA providers. Generally speaking, 401k plans may have higher administrative fees than IRAs, so it’s important to consider all potential costs before making a decision.
It’s also important to understand the types of investments available through 401ks and IRAs as well as any restrictions that may apply. 401k plans may have limited investment options and may require investors to remain in their plan for a certain period of time before money can be withdrawn.
Individuals should also keep in mind that there are two main types of IRAs: traditional and Roth. Traditional IRAs offer tax deductions on contributions but require savers to pay taxes on withdrawals during retirement; Roth IRAs don’t provide tax deductions on contributions but allow investors to withdraw money tax-free at retirement.
In some cases, 401k plans will allow investors the option of rolling assets over into either a traditional or Roth IRA account depending on their individual situation and goals.
Rolling Over Into a New Employer’s 401k Plan
Rolling into New Employer’s 401 k Plan: Pros
- All old 401 k in one financial institution
- No tax distribution when transferring direct rollover
- Safeguards and advantages of current employer’s plan
Rolling into New Employers Plan: Cons
- A new employer may prohibit the transfer
- Limited by the new plan and employers’ options
- Eligibility window may be long and complicated
When starting a new job, rolling 401k over into a new employer’s plan is an option for those who want to maintain the same 401k savings plan. Rolling the 401k allows you to keep your retirement savings intact and potentially benefit from additional investment options or employer contributions.
When rolling 401k over into a new employer’s plan, it is important to take note of any differences such as vesting schedules, transaction fees, and the types of investments available in the new plan. Your financial advisor or the 401k custodian can provide details about these differences so that you can make an informed decision about which plan is right for you.
An important consideration when deciding whether or not to roll 401k over into your employer’s plan is whether or not there are any tax implications associated with the move. If you withdraw money from your existing 401k account and transfer it directly into another 401k account, no taxes will be incurred as long as all rules and regulations are followed.
That said, if money is withdrawn from your old 401k prior to rolling it over, then taxes may be due on that portion of the funds even if they are later transferred into another 401k. This should be discussed with a financial adviser before making any decisions about how to use your 401k.
Finally, some employers offer matching contributions for certain types of contributions made by their employees. When transferring 401 k money into a new employer’s plan, check if they offer matching contributions and abide by their requirements to receive them. Not doing so could mean missing out on additional retirement savings.
Cashing Out Your Old 401k Retirement Account
Cash it out: Pros
- Cash in hand
Cash it out: Cons
- Tax consequences by incurring taxes (taxable event) because you may owe federal taxes and state income taxes on the total account value
- An employer has the option to withhold 20% for taxes
- Penalties if under 59 ½ years of age
- Eliminate retirement money set aside for your long-term goals
Cashing out 401ks from a former company is an option for individuals who need or want access to their 401 k funds immediately. While cashing out 401ks can provide individuals with quick access to money, this option should be avoided if possible due to the high taxes and penalties associated with such withdrawals.
When cashing out 401ks, individuals are not only responsible for paying income taxes on the amount they withdraw, but they also face a 10% additional early withdrawal penalty from the IRS. This penalty applies to 401 k withdrawals taken before age 59 ½ and significantly increases the total tax bill. Furthermore, 401 k funds are meant to be invested for retirement purposes over a long period of time; cashing 401 ks out too soon reduces the power of compound growth and can leave investors without enough savings when it comes time to retire.
Before making any decisions about cashing out 401ks, it’s important to consider all other available options as well as potential consequences that could arise from this decision. Individuals should also weigh their immediate needs versus their long-term financial goals; if there are other sources of funds that can help meet short-term needs, then maintaining 401 k contributions over the long run may be more beneficial in the long run.
To reduce the financial burden associated with cashing out 401ks, some employers offer 401 k loans which allow employees to borrow up to 50% of their vested account balance up to $50,000 at a lower interest rate than available through a traditional loan product while avoiding taxes and penalties associated with distributions. However, if an employee loses or changes jobs then usually any outstanding loan balance will become due and payable within 30-90 days unless arrangements have been made with creditors prior to leaving an employer.
Individuals should also consider the impact that withdrawing 401k funds has on future retirement contributions. When money is removed from a 401k, it reduces available contribution room for future years since contributions are calculated based on plan assets at year-end – meaning less overall retirement savings over time.
Managing Your 401k Retirement Account
401k retirement accounts are a great way to save for the future and can provide individuals with tax benefits, compound growth potential, and access to employer contributions. Deciding what to do with a 401k when changing or leaving an employer is not always easy but there are many options available. Keeping a 401k with a previous employer’s plan may be one of the best choices as it allows funds to continue growing without any associated taxes or penalties.
Rolling 401k over into an IRA could also be advantageous depending on individual circumstances while cashing out 401ks should generally only be done in extreme cases due to the high taxes and penalties involved. Before making any decisions about 401 k, individuals should consider their long-term financial goals versus immediate needs, review all other options available, and seek professional advice.
If you switch jobs, have an old 401k, or have other IRA questions, contact a financial advisor to discuss your old retirement account and your plan’s investment options to help maximize your financial future.