Starting a new job is stressful: new co-workers, new job duties, new coffee machine and if youre at a decent company new options for a 401(k), the workplace savings plan that lets employees make tax-free contributions directly from their paychecks.
Most workers want to roll over a 401(k) when they switch jobs because they already have a 401(k) with a previous employer, and then have to enroll in a new plan with their new employer. Instead of trying to maintain multiple 401(k) accounts, you can consolidate your 401(k) savings so that you can better manage your investments.
Here are a few 401(k) rollover options to consider if you find yourself in a similar situation.
WHAT TO CONSIDER BEFORE YOU ROLL OVER YOUR 401(k)
A 401(k) grows tax-free until your retirement, but when you withdraw the money, it is taxed as income. However, if you withdraw during retirement, you will be taxed at a lower rate. One bonus of a 401(k) is that many employers match an employees contribution to some degree.
A 401(k) rollover refers to transferring tax-protected retirement savings from one account to another generally, from an old employer-sponsored account to a new one. Americans typically complete a 401(k) rollover after switching jobs. Before you decide to roll over your 401(k) to your new company, consider a few factors.
Find out what fees are involved to roll over your 401(k). Some fees will be required, so make sure that they arent high and wont cost more than you want to spend. Also, whether the new 401(k) is run by a bank, mutual fund or insurance company, most providers will try to sell you more expensive products. To know exactly what youll be charged, ask about any expenses related to the 401(k), including:
Investment management fees
The maximum contribution you can make to a 401(k) in 2016 is $18,000. Its important not to over-contribute. If you contribute more money than the maximum allowed, you could pay taxes twice on your contribution amount: during the year you over-contributed and in the year the excess amount is returned to you.
CHOOSING NEW INVESTMENTS
If you roll over your old 401(k) to a new 401(k) plan or into an individual retirement account, youll have to pick new investments. Choosing new investments can be a daunting task, so speak with a financial advisor or do research to ensure that you understand what youll be investing in with your new account.
HOW TO ROLL OVER YOUR 401(k)
Once you change jobs you have at least 30 days to figure out what to do with the old 401(k) funds. The worst move you can make is to switch from a low-cost, diversified 401(k) to a high-fee, commissioned IRA since your goal is preservation of your nest egg, according to Forbes. To help you figure out what strategy is best for your account, take a look at the different ways to roll over a 401(k).
AT A NEW JOB
When you start a new job, you have the opportunity to move the 401(k) funds you had at your previous company to the new companys 401(k). By directly rolling over your account this way, you can avoid taxes and penalties.
Contact the 401(k) administrator at your new job for the new account address, which would be the plan name and your name.
Provide your former employers 401(k) administrator with this new account address.
Confirm that money will be transferred directly from your old plan to the new plan.
Ask for confirmation once funds have been directly transferred.
INTO AN IRA
You can roll over your 401(k) into an IRA by following a few steps:
Contact your former 401(k) administrator to let them know that youre rolling your 401(k) to an IRA, often called a traditional IRA.
The financial company that will be holding the new IRA should then contact the old 401(k) administrator for paperwork to proceed with the rollover.
Choose your new investments.
INTO A ROTH IRA
The steps for rolling over to a Roth IRA are similar to those for rolling over to a traditional IRA:
Contact your old 401(k) administrator to let them know that youre rolling over your 401(k) to a Roth IRA.
The financial company that holds your Roth IRA should contact your old 401(k) administrator to complete paperwork to proceed with the rollover.
Choose new investments.
One of the biggest differences between traditional IRAs and Roth IRAs is when money must be withdrawn: With a traditional IRA you must start taking money out at age 70.5 years old; with Roth IRAs, you are not required to withdraw your funds at any particular age, even when you retire.
Moreover, if you decide to roll over into a Roth IRA from a 401(k), this is considered a Roth conversion and youll pay taxes. If you roll over your 401(k) to a traditional IRA, however, you wont have any federal income tax consequences.
ALTERNATIVES TO A 401(k) ROLLOVER
You arent required to roll over your 401(k) to another investment account when you start working at a new company. What you do with your retirement investments is up to you. Here are a couple alternative options to rolling over your 401(k).
LEAVE YOUR 401(k) IN YOUR PREVIOUS EMPLOYERS ACCOUNT
When you leave a job, you should check your old employers rules for retirement plans for former employees. You might have the option to keep your 401(k) account active even though youre no longer an employee there. Keeping your 401(k) active with your previous employer could be a good option if youre satisfied with that plan, like the investment options that are unique to that plan, or if you just dont know what you want to do with your money.
Some possible disadvantages could exist with this option, though, including:
Inability to make new contributions
Fewer investment options and withdrawal options
Inability to withdraw partial amounts
Cashing out your 401(k) could be tempting during a cash flow shortage to which you might be especially susceptible when changing jobs. However, if you decide to cash out before 59.5 years of age, the money you withdraw will be subject to a 10 percent penalty plus the regular income tax.
Any early withdrawal from a 401(k) will be costly. Take the following hypothetical situation in which you cash out $50,000 from your 401(k). You would end up losing:
25 percent federal marginal income tax: $12,500
7 percent state income tax: $3,500
10 percent early withdrawal penalty: $5,000
By cashing out early, you would end up paying $21,000 in taxes and fees, and taking home only $28,000 of your hard-earned savings.
Cashing out early is not recommended; there is no way to avoid a 401(k) penalty if you withdraw your money early. Plus, youll lose out on compound interest and have to start saving again from scratch. Only in extremely tough financial situations should you consider withdrawing early from your 401(k).
KEEP SAVING YOUR 401(k)
Deciding what to do with a 401(k) plan when switching jobs can be difficult. Youll have to carefully consider your options to figure out whether rolling over to a new 401(k) or other kind of retirement account is best for you. The most costly option would be to cash out your 401(k); cashing out should be reserved for extreme situations only. Whatever route you decide to take with your 401(k), make sure you research your options thoroughly your future depends on it.