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Retirement Perspectives

Changing jobs means having to make decisions about your 401(k). Do you leave it, move it, or liquidate it?

Changing jobs can be an exciting, tumultuous time with many loose ends to tie up before saying goodbye to friends and coworkers. There typically are assignments to complete, a desk to clean out (if you’re lucky, you might find that missing left shoe), farewell lunches, and the obligatory exit interview with Human Resources, among other claims on your attention.

But, amid the last-minute rush of details, it’s important to take care of the assets in your employer-sponsored retirement account. They will remain right where they are unless and until you decide to do something with them. Whatever you do, don’t neglect this important component of your future retirement security.

Multiple Detours on the Road to Retirement
According to a survey by the Employee Benefit Research Institute (EBRI), only 22% of workers are "very confident" about having enough savings for a comfortable retirement. (Calculate how much you will need to save.) Moreover, the EBRI survey revealed that “retirement confidence is ‘strongly related’ to retirement plan participation/ownership, whether in a defined benefit (DB) plan (i.e., a pension), a defined contribution (DC) (i.e., 401(k), or an individual retirement account (IRA).”1

Given the decline of traditional pensions, the reality is that, many people will have to rely on their 401(k) or other defined-contribution plans to build their retirement nest eggs—unless they fritter them away between jobs. Given that the average American will hold 11 jobs between the ages of 18 and 44, there will be ample opportunity for squandering. Indeed, an AON Hewitt Associate survey of employees who changed jobs revealed that 42% cashed out. Only 29% rolled their 401(k) into an IRA or new qualified plan, and another 29% left it in their previous employer’s plan.

When workers change jobs, they have several options with regard to their employer-sponsored retirement savings plans:

  • leaving the assets in the former employer’s plan;
  • cashing out, which will trigger taxes and potential penalties; or
  • rolling the assets over into an IRA.

Now let’s assess the pros and cons of each option, beginning with the most passive.

Do Not Disturb
For some participants, leaving behind their account in a former employer’s 401(k) or other workplace retirement plan may seem like the easiest option, at least at first. In fact, a large percentage of workers do just that. After all, changing jobs generally involves many other details and decisions, such as where to locate your home, a new job for your spouse, and new schools for the kids. Moving your 401(k) or other qualified plan account can be both time-consuming and confusing. By staying put, you won’t have to fill out any paperwork, and you will not be subjected to any taxes or early-withdrawal penalties. You also may be satisfied with your current investments and want to keep them.

There are several potential disadvantages to this strategy, however, including:

  • The primary concern is that you may lose sight of these assets when you move to a different company and start up a new retirement plan. Because you no longer are making contributions to the former employer’s plan, you may neglect it.
  • You are responsible for notifying your former employer (plan sponsor) of any changes to your status, such as a new address, marriage, or divorce.
  • The onus is on you to communicate any changes in beneficiary designations to your former employer.

Taking It with You
If you are changing jobs, and your new company has a plan that allows rollovers, you can move or “roll” your current balance into the new company’s retirement plan. Assuming the transfer is completed within the required 60 days, this would be a tax-free transfer and no penalties would be incurred either. In addition, you now have more of your retirement assets working together so that you can more closely monitor your account balance and your progress. (Compare the financial impact of rollovers versus cash-outs.)

To avoid the possibility of exceeding the 60-day rollover period, which would trigger taxes and potential early-withdrawal penalties, it is recommended that you do a direct rollover in which you never actually take possession of the assets. Also, it is important to note, a rollover may incur administrative costs or other fees. Your financial professional can help you through this process.

Of course, if you like your current investments and are moving to a company whose plan has less-attractive choices, you may not see the advantage in rolling your existing assets into the new company’s plan

Alternatively, you can roll your balance into an IRA. Similar to the previous option, this is a tax-free transfer, and no penalties would apply. You would then have complete control over your retirement assets, which is especially helpful for such things as portfolio tracking, and calculating and taking required minimum distributions (RMDs). You also have access to a much wider range of investment choices, as well as greater flexibility in designating a beneficiary.

Another advantage of rolling your qualified plan into an IRA becomes apparent when you withdraw your assets. There are no mandatory tax withholdings on IRA withdrawals, while withdrawals from qualified plans are subject to a 20% mandatory federal tax withholding. And IRAs carry additional exceptions to the 10% early-withdrawal penalty, including higher education costs, first-time home purchase ($10,000 lifetime limit), and medical insurance premiums while unemployed.

Another potential advantage of going the IRA rollover route is that you can combine your IRA rollover with other IRAs you already own, thereby helping to consolidate your retirement savings. For example, if you’ve had several jobs and participated in multiple 401(k) or similar plans, the onus is on you to track your accounts over the years, as you move homes, change jobs, change beneficiaries, etc. It can be cumbersome to keep up with multiple accounts, and there may be various fees and charges associated with your previous accounts that could be eliminated by rolling them into your new account.

Meanwhile, you can add to your traditional IRA account annually ($5,500 per year if younger than 50 and $6,500 per year if 50 or older). This contribution also may be tax-deductible, depending on income, and whether you or your spouse is an active participant in an employer-sponsored retirement plan.

Finally, you have the option of converting all or part of your traditional IRA account to a Roth IRA. The assets that are converted would subject you to income taxes, but the early-withdrawal penalty would not apply. You should consult with your financial advisors and/or tax professional before choosing this option.

This is not to say that investors who roll their qualified plans into IRAs will avoid potholes. Your IRA may or may not perform better than it would have in the previous account. Individuals who pursue this course of action may violate the holding rules, resulting in potentially significant penalties.

Also keep in mind that:

  • Governmental 457(b) plans are not subject to the 10% penalty on withdrawals made before age 59½. However, the penalty reattaches if the 457(b) account is rolled into an IRA and a subsequent withdrawal is taken before age 59½.
  • Distributions from a qualified plan or 403(b) after separation from service during or after the calendar year in which you attain age 55 are  exempt from the 10% early-withdrawal penalty. (The exemption is not extended to IRAs.)
  • Distributions from a qualified plan or 403(b) to a former spouse in the form of a qualified domestic relations order is exempt from the early-withdrawal penalty of 10%. (The exemption also is not extended to IRAs.)
  • Unlike with 401(k) plans or 403(b) assets, IRA participants must start taking RMDs, beginning at age 70½.

Cashing OUt May Be the Worst Option 
As mentioned, more than 40% of all those who change their jobs cash out their 401(k) balances. But what may seem like a good idea in the near term (you have some ready cash in hand), may turn out to be a very costly idea in the long run.

There may be significant penalties involved with this option. You generally will face a 10% penalty if you are younger than 59½, and the amount that you cash out will be subject to both federal and state (if applicable) income taxes. But most important, you will lose the potential benefit of tax-deferred compounding on the assets you have accumulated.

Are All Your Resources Working Together?
Many individuals have retirement assets in several different places, such as company pension and one or more IRAs, as well as traditional investment accounts. It might make sense, then, for you to bring these different accounts together. With all your retirement assets in one place, it will be much easier to develop a strategy, assemble your portfolio, monitor performance, and calculate RMDs. Managing material changes in status and beneficiary designations also will be easier. And it may help your financial advisor make a holistic recommendation for a balanced portfolio, best suited to your risk tolerance, time horizon, and investment goals.

 

1 Employee Benefit Research Institute Retirement Confidence Survey 2015.

 

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

 A 401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (reduction) contributions on a pretax or aftertax basis. Earnings accrue on a tax-deferred basis.

 A 403(b) is a retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement income accounts can invest in either annuities or mutual funds. Also known as a tax-sheltered annuity (TA) plan.

A 457(b) is a nonqualified, deferred-compensation plan established by state and local governments, tax-exempt governments, and tax-exempt employers. Eligible employees are allowed to make salary deferral contributions to the 457 plan. Earnings grow on a tax-deferred basis and contributions are not taxed until the assets are distributed from the plan.

Minimum distributions must be taken from traditional IRAs by April 1 following the year that a person turns 70½. A minimum distribution must be taken from the IRA in each subsequent year. Mandatory distributions that represent deductible contributions and all earnings are taxed as ordinary income. Mandatory distributions based on nondeductible contributions are tax-free.

Combining a rollover and a contributory IRA may result in the loss of income averaging and capital gains treatment with respect to the rollover assets, if applicable. It may also affect the calculation you may need to perform to exempt your rollover IRA from any claims in the event of bankruptcy . You should consult your tax advisor before combining accounts.

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

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