Considerations for Your 401k in a Job Transition
The current economic conditions have led to a tremendous amount movement in the job market. Many individuals are either searching for a job or have moved on to start a new one. When one becomes unemployed, the status of their retirement plan may be the least of their concerns. And for a new hire, it’s likely that all of his or her focus will be with their new job, giving little thought to their 401(k) at their previous employer. As a result, individuals often leave their retirement savings in their previous employer’s 401(k) (or 403(b) plan) after they have moved on to other employment.
If you have a 401(k) with a previous employer, you have four choices regarding what to do with it: (1) take an early distribution, (2) do nothing, (3) move it to your current employer’s 401(k), or (4) roll it into an Individual Retirement Account (IRA). You should know the benefits and implications of each option and consider which is best for your situation.
Early distribution
This option is costly, and in most cases, should be avoided. Distributions from a 401(k) that occur before the participant reaches the age of 59 ½ are subject to a 10% penalty. There are a few exceptions to the penalty that can be reviewed on the following link www.irs.gov/taxtopics/tc558.html. The participant must also pay regular income tax on the distribution.
When in a cash crunch, rather than deal with the penalties and taxes associated with an early withdrawal, many individuals will borrow against the value of their 401(k). However, loans against your 401(k) are not allowed if it is held at a previous employer.
Do nothing
If you choose to do nothing, make sure the balance of your 401(k) is large enough to keep it with the previous employer. Employers have the right to require a minimum balance in your 401(k), which can legally be no more than $5,000. The first obvious benefit of this option is the simplicity. If you are content with the associated fees and the performance of your investment, and your access to account information will be unchanged after you leave, perhaps it is best to just leave it alone.
The downside to this option includes the lack of fee transparency, limited investment choices, and access to information. Fees for the administration of the 401(k) are often paid by the participants. In addition, there are typically fees associated with investment products held in the account, like with a mutual fund. The lack of fee transparency can make it very difficult to discern the true expense of keeping the 401(k). Investment choices in a 401(k) are predetermined by the plan administrator, so typically a participant’s universe of investment options is limited. If an employer makes changes to a plan, employees that are no longer with the company may not receive pertinent information related to those changes in a timely manner. In addition, complications can ensue if your previous employer goes out of business or is acquired.
Move it to your current employer’s 401(k)
If you don’t like to think about investment options and prefer to have simple, pre-determined choices based on risk tolerance, it may be best to transfer the balance from your old 401(k) into your new one. However, not all company plans allow for a 401(k) transfer. An additional advantage to this strategy is that you may borrow against the value of your 401(k), if the company’s plan allows it. Loans are capped at 50% of the account value or $50,000, whichever is lower.
By transferring your old balance to the new 401(k), you may face the same issues of having a lack of fee transparency and limited investment options. If you like having the ability to borrow against your 401(k) and to have pre-determined investment options, this may be a good choice for you.
Rollover the 401(k) into an IRA
Many individuals choose to roll their 401(k) into an IRA and keep the account at a brokerage. This option provides the most flexibility in terms of investment choices, and if held at a discount brokerage, costs can be very low. However, trading through a discount broker could intimidate those who are unsure how to properly allocate their investment portfolio based on their tolerance for risk and desired return. In an IRA, your investment options are almost unlimited.
If you decide to rollover your 401(k) to an IRA and would like assistance with investment selection, you can choose to work with a traditional broker or with a fee-only registered investment advisor. The additional expense of getting expert advice can pay off over the long-term.
Compensation for this advice differs. A traditional broker is compensated by commission, which is usually based on executing an investment transaction he or she recommends to you. Alternatively, a fee-only advisor serves in a fiduciary role, and provides investment advice for a flat fee or as a percentage of the investment value. A fee-only advisor typically makes an effort to minimize transaction fees for the client because he or she is not paid a commission.
Another option would be to roll the 401(k) into an IRA at mutual fund company. This is probably the cheapest way to invest in a mutual fund because it avoids transaction costs. However, flexibility is limited because you can only choose from various options in the same mutual fund family. You will also pay annual expense fees charged by the mutual fund company.
Individuals tend to put off consideration for their 401(k); perhaps because it’s seems complicated, intimidating, or just a hassle. In most cases, the rollover process is fairly simple, and plan administrators are helpful in providing the necessary paperwork and guidance to complete it. Once the account is rolled into an IRA, then investment decisions have to be made. Before making investment decisions, you should be certain that you understand which investments are best for your level of risk tolerance. If you need guidance in this area or any others related to your retirement planning, you should contact an investment professional.