I recently finished up teaching my retirement class at Cape Cod Community College in Hyannis. The class is designed to teach pre-and post-retiree’s how to develop and to implement a retirement system to help give them a peace of mind leading up to and into retirement. The class is very interactive and stirs up a lot of questions.
It has become a very popular class. In fact, it has become so popular that WXTK (95.1) approached me to do now a radio show hosted by me that airs each Saturday at 5PM. The radio show is designed to help teach its listeners how to develop a sound retirement system.
This week I would like to spend our time together to shed some light on one of the most common questions I get asked in class . . . what to do with old 401(k) accounts.
If you are like some of my students and have changed jobs, you also may be wondering what to do with your old 401(k) account. If you’ve been sitting on that decision for a while, you’re not alone. Many of us put off making decisions for years, sometimes decades. The result is that some of us miss retirement benefits we’ve earned. By some estimates, billions of dollars of retirement benefits remain unclaimed each year. You don’t have to let this happen to you – it merely requires some planning and a strategy.
For most of us, the days are long past of being able to work at one company your entire life, then retire with a fat pension and a nice gold watch. Instead, most of us can expect to switch jobs throughout our professional lives. In fact, the average tenure of an American worker in 2018 is only 4.2 years, according to the Bureau of Labor Statistics.
Choices about your retirement savings abound when you change jobs. Investors are left to keep track of several retirement savings accounts from past employers, each with different investment options, fee structures, and rules – a maintenance headache. Determining the most appropriate course of action can be confusing, and that confusion can quickly overwhelm. The easiest thing is often to just do nothing, which is why my students end up in this quandary to begin with.
Let’s review some options. You can leave the money where it is (depending on your balance), roll it over to your employer’s new plan (if one is offered), roll it over to an Individual Retirement Account (IRA), or take a cash distribution.
As I explained to my students, there’s no such thing as a “good” or “bad” investment, but rather appropriate or inappropriate. And there’s no right or wrong choice to make here, only ones that will be appropriate or inappropriate depending on the desired outcome.
When you leave a job (either voluntarily or involuntarily), you’re entitled to a distribution comprising of your contributions, your employer’s contributions, and earnings on those contributions. The final amount is also contingent on your individual plan’s vesting schedule (typically from 3-6 years). If you have taken out any loans from your plan, the outstanding balance must be repaid, or it will be taxed as a cash distribution.
Taking a cash distribution from your 401(k) will be the costliest choice for most investors. You’ll be taxed at ordinary income tax rates plus a 10% penalty if you’re under age 59 1/2. Unless you need the money in an emergency, there are more appropriate ways to make your money work harder for you.
In most plans, if the vested balance of your 401(k) plan is more than $5,000, you can leave the money where it is in your employer’s plan until you reach normal retirement age. You may not make any additional contributions, but you’ll continue to earn gains and losses on your investments. Your employer must also offer you the ability to roll over those funds to an IRA or your new employer’s 401(k) plan.
One reason to consider a rollover to your new employer’s plan is to consolidate your retirement investments into one account to make it easier for you to manage.
Before you do that, it is important to review your new employer’s investment options to see if the investment align with your long-term investment goals. Folks, often times I find that the investment options may be inappropriate for folks approaching or in retirement due to a lack of downside risk management.
As I explained to my students, make sure you understand how investments will behave, particularly during down years such as 2001, 2002, and 2008. At this stage of their financial lifecycle, they just do not have the time to recover from such devastating years.
Many 401(k) plans have loan provisions. While it’s best to consider your retirement savings for your retirement, everyone’s circumstances are different. If the need arises, it can be an essential consideration for some investors.
A popular consideration we discussed in class is to roll over your 401(k) to an IRA. IRAs can provide you with a greater range of investment choices than your employer’s 401(k) plan. Many IRA’s offer strategies designed to manage downside risk helping to mitigate loss in times of market stress. Additionally, you can move your money between different investments and to different IRA trustees and custodians.
You can shop around if you become unhappy with your investment performance, or because you want to add some diversification to your portfolio that would be more difficult to manage with a different plan. Because of regulatory differences, IRAs lack the added administrative expenses imposed by 401(k) programs, which can make your costs easier to control.
The IRS has different penalty exceptions for IRA distributions, as well. You can withdraw up to $10,000 from an IRA to put towards the purchase of a home if you’re a first-time home buyer, for example, or to pay for qualified higher education expenses for you or certain members of your family. It’s best not to think about your retirement savings as a revolving credit account, but those provisions do exist.
If rolling over your old 401(k) to an IRA sounds like the right move, it’s best for you to set up your new IRA in advance, then request a direct rollover. A direct rollover transfers your assets from the old trustee to the new trustee, saving you from tax complications and penalties for which you’d be potentially liable for if the check were made out to you directly.
If you’re changing jobs now or you’ve done so in the past, and you’ve left behind your retirement assets, make time to review your options and see if you can consolidate your investments in your current 401(k) or transfer them to a new IRA. Work with your plan provider and your retirement specialist to make the process as smooth as possible.
My students attend the class because they want their money to work for them. So should you. Keep your investment strategy aligned to help you reach your long-term goals, no matter where you are in your financial lifecycle, especially as you are approaching or already in those golden years.
That’s why I tell you every week, keep vigilant and stay alert because you deserve more.
Have a great week!
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, a wealth management firm with offices in Falmouth, Duxbury, and Mansfield. Jeff can be reached at firstname.lastname@example.org.
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