Keeping It (Your Retirement Savings) Together

I’ve had the pleasure so far this year of starting relationships with a number of new clients, virtually all of whom are under 35 years old.  I have found them to be very interested in taking charge of their financial futures and much of what we’ve discussed includes some basics of retirement accounts.  One of the key things these clients weren’t aware of was precisely what options you have for a 401k plan when you leave an employer.  Since these options are universal, I thought I would share them in this blog. 

When you leave a company, you have 4 choices for your 401k:

  1. You can leave it there.  Unless your balance is very small, typically less than $1000, you can leave the money in the 401k plan.  Some plans do make you take the money out if it’s a small amount, but otherwise it can stay.  If the plan contains good investment choices and has low fees, this may be an acceptable option.  The downside is that, after a number of years, you may not always remember how to contact that plan when it comes time for you to access the money.  The company may also change its 401k plan provider and you have to keep track of where your money goes as well as whether the new plan is still right for you.

  2. You can cash out – you are allowed to cash out the balance in your plan.  A withdrawal from the plan is considered taxable income, so you will pay taxes on the money and if you are less than retirement age you will pay a 10% penalty (this is typically 59 ½ but there is a provision in the 401k rules that you can take withdrawals under certain conditions if you have retired and are 55 or over).  I don’t consider this a good option, but it is legal.

  3. You can transfer it to your new 401k – you can transfer the balance from your old company’s plan into the plan of your new company if the new company’s plan allows it (and most do).  This may be a good option if the new plan has better fund choices, lower costs, etc.  The added advantage is that you don’t have to keep track of the old plan.  A direct transfer of this type doesn’t generate taxes

  4. You can roll it into an IRA – a direct rollover into an IRA is also a non-taxable event.  The added advantage is that usually a much larger universe of investment choices are available to you rather than the fixed number of funds in most plans.   Also, if you choose to open an IRA with a financial advisor or planner, this may be a way to combine investment management and financial planning, but can cost more than leaving it in a 401k (make sure you’re comparing apples and apples here and know what you get for your money).  Given that many workers in today’s economy change jobs many times over their working career, an IRA can also be a good “core” account, into which you can roll old 401k plan balances over and you can make contributions to it during times when you might be working as a contractor, 1099 employee,  free-lancer, etc. or would otherwise not have access to a retirement plan.

There are a few other things to remember among these choices.  First, 401k plans do have the option of starting to take income once you have retired and are 55 or older. Withdrawals from IRA accounts are penalized if you withdrawal money before age 59 ½.  You can’t borrow against an IRA, where you can from some 401k plans (although I don’t recommend it other than as an absolute last resort).  A 401k has unlimited protection from bankruptcy and creditor’s claims, where IRA accounts are only protected up to a little over $1.2 million and creditor claims vary by state.  Also, you may not want to roll company stock out of a 401k plan – future withdrawals would be taxable income but you can roll company stock into a taxable account, pay tax on the original basis, and capital gains on anything above that – usually a much more tax efficient option.

There are a few other differences, such as if you plan to work beyond age 70 1/2 that you will want to understand if that applies to you.

Again, let me reiterate that I don’t think option #2 above is a good option, but the others are good ways of keeping your investments together where you can keep an eye on them and have a better sense of how much you are accumulating toward your retirement goals.  The rules are fairly straight forward, but there are some major issues if you don’t get it right.  That’s why I recommend you at least think about working with a financial professional.

As always, if you have a topic you would like to discuss or see in a future blog post, feel free to email me at greg@affinityassetmanagement.com.