About 55 million Americans contribute to a 401(k) plan through their employer. And according to a January 2018 report from the Bureau of Labor Statistics, the average person changes jobs ten to fifteen times (with an average of 12 job changes) during his or her career. Statistically, a few million workers a year are faced with the dilemma of what to do with their employer 401(k) plan when they switch jobs.
Whether you’ve been at your current job for one year or fifteen, your 401(k) is an important asset to take control of. And when the time comes to switch jobs or organizations, it’s helpful to be aware of your options so that you can make the right money moves for your future.
A 401(k) plan allows employees to make automatic salary deferrals, either as a percentage or dollar amount, directly into an investment account. Many employers even match a percentage of the employee’s contribution in the account as an incentive to save for retirement. 401(k)s have special rules around withdrawals and taxes, which make them a bit more complicated than an individual investment account you can open in five minutes or less.
You can access your account through the investment platform that your employer picked. Make sure you have login information (reach out to an administrator or HR if you don’t know how to access your information). Keep a record outside your work computer and work email address (a third party password management app can be a great idea). When you first log in, ensure that you pick an investment strategy—most investment platforms make this super easy to do. Pick a fund or investment split that correlates to your risk appetite. Here’s a quick guide from Fidelity:
We’re not very dramatic people, so believe us when we say that cashing out a 401(k) can cost you hundreds of thousands of dollars over the course of your career.
And yet, nearly half of employees cash out their 401(k) balance when they move to a new job, according to a survey by Hewitt Associates. The appeal of cash today wins out over any sort of saving plan for the future you—sort of the same way people are tempted to spend their tax refund or a small inheritance.
For instance, say you cash out $80,000 from your 401(k) at 45 and you’re in the 28 percent tax bracket. After paying $22,400 in taxes and $8,000 in an early withdrawal penalty, you will still be left with a pretty big pile of money, about $49,600, right? Had you left the money alone and didn’t contribute a dollar more into the account, let it grow at six percent a year until you hit 65, you would have had more than $256,000.
The IRS imposes strict distribution rules because of the preferential tax treatment. Withdrawing money from a 401(k) before age 59 and a half would make it subject to ordinary income taxes, plus a 10% penalty. The penalty doesn’t apply, however, if you’re over age 55 and have left the company.
So clearly you shouldn’t withdraw cash from your 401(k) when you leave a job, but how about ignoring it and letting it grow for the number of years between now and retirement?
Whether or not you choose to leave your account as is or roll it over to a new account depends on the fees you’re being charged. A lot of employer sponsored 401(k)s are riddled with fees—even 1-2% can add up over many years.
In most cases, a rollover IRA is a better option than leaving the money in your old 401(k) or transferring it to your new employer’s plan. Fees are typically lower and you’ll have more investment options.
The easiest time to move the money in your 401(k) is when you’re starting a new job. If your new employer offers a 401(k) plan, you can transfer your assets from your old plan into your new one without a tax penalty. If you are starting a new job that offers a 401(k) plan, you may have the option to bring your old plan over and consolidate it with the new one without taking a tax hit. If the new plan has great investment options, this might be a great move.
The specifics of moving your 401(k) over (or “rolling” it over in popular terminology) depend on the plan administrator. In most cases, a quick email with the administrator will get the process going and they’ll usually write a check to your new 401(k) or IRA account. This way, you don’t have to pay taxes or penalties. Once your new account or plan is all set up, you can choose new investment allocations and contribution percentages.
Another option is to open up an individual retirement account (an IRA) and move your 401(k) assets into this account. This works especially if you don’t have a new job lined up as you leave your old one. IRA accounts may also have more investment options and lower fees than employer 401(ks), which is another great reason to look into this option.
According to personal finance expert Ramit Sethi, about half of twenty-somethings cash out their 401(k) plan when they switch jobs. Because the balance of the account is probably on the lower end and there might be pressing financial obligations like student loans and credit card debt. At some organizations the company will automatically distribute the money to you if your balance is $5,000 or less when you leave—minus the 20 percent it’s obligated to withhold for the IRS.
Then, to avoid getting hit with the tax bill yourself, you must roll the money into a new 401(k) or IRA within 60 days. Plus, you have to add in the missing 20% yourself.
Switching jobs can have a lot of emotions tied into the process (you may even be surprised at how you feel about “just a job”). After all, we spend a large part of our day with our coworkers, helping the organization succeed. At a time of high stress and high emotions, it can be helpful to put one administrative task on autopilot by knowing exactly what to do with your 401(k). We hope this article has helped you make some financial decisions easier while avoiding an unexpected tax bill at the end of the fiscal year.