According to the site, The Balance Careers, the average person today changes jobs ten to fifteen times (with an average of 12 job changes) during his or her career. While there is a multitude of factors that go into changing jobs, one critical factor that people should decide on in conjunction with a job change, is what to do with their employer-sponsored retirement plan or in most cases a 401(k) or 40(b).
There are four potential options that one could consider how to handle the care and treatment of your retirement plan;
- Take your money out in a lump sum payout,
- Leave assets in the old employer plan,
- Rollover assets from the old company to a new company retirement plan, or
- Rollover assets into one of three IRA options.
The decision tree below is a great visual for the details that we are about to dive into. The tree is color-coded in that red boxes are bad results, orange may be good or bad, and green boxes are great attributes.
Taking your money out in a lump sum
This first option is the one option that I would not recommend to anyone unless you have a financial emergency and you have no other possible sources of funds to cover a catastrophic event. These are certainly difficult situations, but until you have exhausted every possible option, I would not touch these assets. If you do decide to take money out, you will be subject to a 10% early withdrawal penalty unless you are older than 59 ½ and you will be taxed at your ordinary income rate. There are a few exceptions that apply to the early withdrawal penalty, but the taxes are unavoidable.
Leave your asset in your old employer plan
I don’t recommend this option either for the following reasons;
- Your assets are in essence locked up. You can no longer make contributions to the plan, and you can no longer access your money through a potential loan option if your plan even offers a loan option.
- Increase in fees. Some plans won’t allow you to keep assets in a plan if you are no longer employed by the plan sponsor (old Company). If they do allow your assets to remain in the plan, it could be for a limited amount of time, and they could start charging you maintenance fees to keep the account open.
- Limited investment options. Your investable options will always be limited to whatever options your company plan allows for in the plan. Most plans only offer a limited lineup of mutual funds that can carry high expense fees while underperforming their respective benchmarks. A double negative.
Rollover assets from the old company to a new company retirement plan
While these days it is highly unusual for a medium or large company not to have an employer-sponsored retirement plan, smaller companies may not have a retirement plan option. In this situation, rolling over assets from the old plan is simply not an option.
But what if it is an option? Is it a good option? Below are some points to consider.
- There are no penalties or taxes for rolling over assets from one qualified retirement plan to another when you change jobs.
- You may still be faced with limited investment options. Just like leaving your assets in your old plan, you are still limited to whatever options your company plan allows for in the plan, and those could be better or worse than your previous plan.
- If your new company offers a loan option as part of their retirement plan, then you would have access to your assets via a loan if you were to roll those assets over. Be careful though; most plans typically have a waiting period before you can even access a loan.
Rollover assets into one of three IRA options
This is the recommendation that I make to most people for the following reasons;
- It provides the most investable options. Within an IRA, you can invest in individual stocks, bonds, and ETFs vs. only mutual funds which are typically what most employer-sponsored plans offer. This allows you to create a diversified portfolio usually at a lower cost.
- Lower costs. Depending upon your old company’s investment plan lineup, the investable options (again typically mutual funds) charge fees and in some case those fees can be very high between 1% and 2%.
- No penalties or taxes for rolling over assets. Like rolling your assets over from an old plan to new plan, there are no penalties or taxes for rolling over assets from one qualified retirement plan to an IRA when you change jobs.
If you choose to roll your assets over to an IRA, there are three IRA options that you will need to choose from.
- Traditional IRA. If your previous plan had all pre-tax contributions which mean you have not paid tax on those assets, you would then roll those assets into a Traditional IRA
- Roth IRA. Some plans now offer the option for an after-tax contribution such as a Roth, or a plan may allow you to make both pre and after-tax contributions. Whatever the case, you need to align your contribution up to the correct IRA option to avoid paying any unnecessary penalties and taxes.
- SEP. For those of you who may be striking it out on your own, A SEP IRA is an option for small businesses to make pre-tax contributions to for both owners and their employees. Pre-tax contributions from another qualified plan could be rolled over into a SEP. Deciding if a SEP is a right option for your business is another topic, but I wanted to make people aware that this is an option.
What to do with your assets is a critical factor during a job change which can often be overlooked. However, missing the opportunity to transfer your assets in the most efficient manor into the most effective savings option, could have a detrimental impact on your wealth management plan. Determining what the best option for you should go hand in hand with the decision to change jobs.