According to a recent piece in Barron’s , most Americans change jobs an average of 12 times throughout their lifetime. Many people often make rushed decisions and think they need to pack up their savings when they leave a job. On the other hand, some people pay no attention when they move from job to job and leave a trail of 401(k) plans behind them. With any employment change, it’s important to know which mistakes to avoid when it comes to your 401(k).
Here are some tips regarding your 401(k):
Cashing out and not reinvesting your funds in a qualified retirement plan is a mistake. People don’t realize the cost to their financial security by cashing out on their 401(k) and that cost includes an immediate tax hit – income taxes plus another 10% early withdrawal penalty if you are younger than 59 ½.
Employees who decide to move their money to another 401(k) plan or an IRA typically have two options—transfer the funds directly to another account, or do a rollover. Although “rollover” is a term widely used to mean moving money from one retirement account to another. That money is best moved by direct transfer, but some employers will send a check. You have 60 days to roll that money over to an IRA or other qualified plan. If you miss that window, there is a grace period (with a penalty fee), but this is offered only once every 12 months. It’s best to do a direct transfer to avoid this becoming a problem.
There are plenty of good reasons to move your money into an IRA (individual retirement account). These accounts aren’t linked to any one employer and consolidate your money into a single retirement account. However, your employer’s plan may offer you access to investment options, tools and institutional pricing that you might not get with an IRA. In addition, the creditor protection for IRAs varies by state and might not be as secure as a 401(k) option.
There may be other strategies to consider when weighing a job move, although most people associate 401(k) plans with pretax contribution. One option may be to convert the savings to a Roth IRA; you’ll owe income taxes on what you convert, but future growth and withdrawals will be tax free. If your income is lower that year, the tax impact will be less. For those who’ve accumulated their employer’s stock in their 401(k) plans, leaving a job may open the door for an often overlooked tax break. Normally, distributions from a tax-deferred retirement account are taxed as ordinary income. Under the so-called “net unrealized appreciation” break, you can opt to withdraw your employer’s stock as shares. You’ll owe ordinary income tax on the cost basis, but not on any gains. When you sell the shares down the road, you’ll owe capital-gains tax just on the shares’ appreciation.
As we enter the 4th quarter, and you may have received all your September 30th statements from all your old 401k plans, use this opportunity as a good time to evaluate and understand what you have and you options. Keeping regular tabs on what is going on with your investments is critical to ensuring they line up with your goals for the future.