Should You Stay in Your Employer’s Retirement Plan After You Retire?
Any time you leave an employer, it forces you to make a key retirement planning decision: Should you leave your 401(k) balance in your prior employer’s plan or move it somewhere else when you leave?
It’s a decision you face whether you’re actually retiring or just moving to another employer. You need to think through the issues carefully; otherwise, it could disrupt your retirement investments and cause you to pay unnecessary taxes.
You have a few different options, depending on your situation. In some cases, there could be tax consequences if you don’t make a decision quickly enough.
So, as soon as you know you may be leaving an employer, you should either research the possibilities yourself or review them with a financial advisor.
This article explores the choices available to you and explains why the best move might involve taking your 401(k) balance with you when you leave your employer.
What is a Financial Advisor, and How Do They Work?
Can You Leave Money in a Former Employer’s Retirement Plan?
The first question is whether you have the option to leave money in a former employer’s retirement plan. The answer depends on the rules of that plan and the size of your 401(k) account balance:
If you have less than $5,000 in a 401(k) plan, your former employer may be able to force you to leave the plan when you leave the company. This depends on the rules that employer has set up for the plan.
Less Than $1,000 in a 401(k) Plan
If you have less than $1,000 in the plan, the employer can simply cut you a check for the balance. This leaves you responsible for taking action to avoid tax consequences for that money. Those consequences are explained in the next section of this article.
Between $1,000 and $5,000 in a 401(k) Plan
If you have more than $1,000 but less than $5,000 in the plan, the employer can roll the money over into an IRA rollover on your behalf. This avoids the tax consequences, but the choice of that IRA will be the former employer’s rather than yours, unless you take action first.
More Than $5,000 in a 401(k) Plan
If you have accumulated more than $5,000 in the plan, you should be able to keep your money in your existing plan after you leave the employer. However, there are a couple of wrinkles to this:
If your plan balance later drops below $5,000 due to market fluctuations, the plan sponsor may be able to force you out in the future. So, if your balance is only slightly above $5,000 when you leave the company, you are in danger of being forced out of the 401(k) at some point.
Balances you rolled into the plan from a previous employer don’t count toward these limits. So, if you have an $8,000 plan balance but $5,000 of that was rolled in from a previous employer’s plan, you only count as having accumulated $3,000 in the current plan. This may leave you open to being forced out of the plan if you leave that employer.
The bottom line is that in some cases you may be forced to make a decision about what to do with an existing 401(k) balance when you leave your employer. Even in cases when you have the right to remain in the plan, there may still be better options for you.
IMPORTANT NOTE: This may be a time-sensitive decision in order for you to avoid tax consequences due to 401(k) withdrawal rules.
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What to Know About 401(k) Withdrawal Rules
It’s your age at the time you make a withdrawal that determines how 401(k) withdrawal rules will apply to your situation – in particular, age 59 1/2 and age 72.
401(k) Withdrawal Rules After 59 1/2
When it comes to taking money out of a 401(k) plan, 59 1/2 is a magic number. That’s the age at which 401(k) distributions are no longer subject to a 10% tax penalty.
The rules pertaining to 401(k) withdrawals after 59 1/2 still generally involve some tax consequences. Unless you are in a Roth 401(k) option, your 401(k) distribution will be subject to ordinary income taxes. Just 12% of 401(k) participants use Roth options, according to Vanguard.
Not only are traditional 401(k) distributions taxed, but, by being included in your income, they may bump you into a higher tax bracket. That’s why it’s wise to spread 401(k) distributions out over time rather than to take too much out in one year.
All of the above tax consequences can be avoided if money from a 401(k) is rolled into another tax-deferred plan, such as a 401(k) at a new employer or an IRA. You have 60 days after receiving a distribution from a plan to roll it into a new retirement plan to avoid these tax consequences.
If you are under age 59 1/2, there will almost certainly be tax consequences from taking money out of a 401(k) unless you roll it into a new retirement plan.
If you are 59 1/2 or older, there may still be some tax consequences.
These tax consequences are the reason you should take charge of what happens to your 401(k) account when you leave your employer.
401(k) Withdrawal Rules After 72
The other key age for retirement plans is 72. You can leave money in a retirement plan until you reach that age. At that point, you have to gradually start taking money out in the form of required minimum distributions. Even then you can leave most of your balance in the plan for years to come.
Being able to leave money in a retirement plan even after you retire is important because it allows you to continue to defer taxes on much of your savings during your retirement years.
Leaving Your Employer? Here Are Your Options
Here is a run-down of the choices you may have for your 401(k) balance when you leave your employer:
Leave Money in the Former Employer’s 401(k)
If your situation allows it, you can simply leave your balance in your prior employer’s 401(k) plan. However, you won’t be able to make new contributions to that plan, nor will you be eligible for any employer contributions to it.
Transfer Your Balance Into a New Employer’s Traditional 401(k)
Rolling a balance from a traditional 401(k) plan into a new employer’s traditional 401(k) allows you to avoid all tax consequences. Your subsequent 401(k) contributions will simply be added to the rolled-over balance in the new employer’s plan.
If you are a fully retiring, this option won’t be on the table since you won’t have a new employer. However, people who are semi-retiring should be aware of this option.
Transfer Your Balance Into a New Employer’s Roth 401(k)
If your existing balance is in a Roth 401(k) option, it doesn’t make sense to roll it into a traditional 401(k) option. You will have already paid taxes on the money in a Roth option, which means your eventual distributions from it should be free of taxes.
If you are in a traditional 401(k) option at your old employer, you could roll that into a Roth 401(k) at your new employer. This would mean paying taxes on your existing 401(k) balance in this tax year. However, it would not be a considered a distribution subject to the 10% early withdrawal penalty.
Rolling over from a traditional to a Roth plan makes sense if your existing balance is relatively small and you expect your overall income in the year of the rollover to be relatively low. The combination of those two things should put you in a fairly low tax bracket that year.
However, if you do a traditional-to-Roth rollover, make sure you will have enough cash on hand to pay the income taxes on the rolled-over balance.
As with rolling your balance into a traditional 401(k) at a new employer, rolling into a Roth 401(k) is not a possibility if you are retiring fully. However, if you are shifting into semi-retirement with a new employer, it may be worth considering.
Roll Your Balance Over Into a Traditional IRA
From a tax standpoint, this would be the same as a rollover to a traditional 401(k) as described above.
The only difference is that you would be responsible for finding your own investment options, rather than choosing from the menu of a 401(k) plan.
This may be a good option if you are fully retiring and need a vehicle for managing your retirement savings in retirement.
Roll Your Balance Into a Roth IRA
From a tax standpoint, this would be the same as a rollover to a Roth 401(k), as described above.
The key difference is that you would be responsible for finding your own investment options, rather than choosing from the menu of a 401(k) plan. If you are fully retiring, this may be a good option for managing your savings through your retirement years.
Cash Out Your 401(k) Balance
You could take the distribution as cash, but this is likely to have tax consequences.
If you are under age 59 1/2, you would pay a 10% tax penalty in addition to any ordinary income tax due on the balance.
>>401(k) Rollover – Tips for 401(k) Investing
Consolidating 401(k) Account Balances: Pros and Cons
Whether it’s rolling into a new employer’s 401(k) or your own IRA, you have options for avoiding tax consequences from taking money out of an existing employer’s 401(k). So the question of whether to leave the money behind or take it with you really comes down to investment issues.
Moving the money into a new plan allows you to add new contributions to your previous balance. This also makes it easier to keep track of your retirement accounts.
Most importantly, having your retirement money all in one plan makes it easier to follow a consistent asset allocation strategy suited to your needs. Think of this as having all your money working toward the same goal as opposed to potentially following inconsistent investment approaches.
Even when you are retiring, remaining constructively invested through your retirement years is vital to keeping pace with inflation. Coordinating your investments in one retirement account can aid that investment effort.
The only reason for leaving a 401(k) balance with a previous employer for an extended period would be if you thought that employer’s plan was much better than the 401(k) plan at your new employer or an IRA you could start on your own. The investment options available and the overall cost would be factors in deciding that.
Deciding What to Do About Your 401(k) Balance? Key Questions to Ask
Based on all of the above, the following is a list of questions that might help you narrow down your choice of what to do about your 401(k) balance when you leave an employer:
- Do you have the option of leaving money in your former employer’s plan?Check with the benefits office of the former employer to see if this choice is even on the table.
- Are you older than age 59 1/2?This determines whether or not you would face an early withdrawal penalty if you took money out of the plan without rolling it into a new retirement plan.
- Are you currently in a traditional or a Roth 401(k) account?Generally speaking, you should roll into the same type of option in new retirement plan, unless you a prepared to pay taxes on the money now by rolling from a traditional to a Roth option.
- Do you expect to join a new employer at some point?If you are fully retiring, a transfer to your own IRA may be your best option. However, if you think you will work part time or start a second career, it may be more convenient to leave your retirement balance in your existing plan until you figure out what your next move is.
- Does your new employer have a 401(k) plan?If not, the best course might be to roll the money over into an IRA.
- Does your new employer’s 401(k) plan have a Roth option?Not all 401(k)s have Roth options. If you’ve been in a Roth 401(k) but your new employer does not have that option, you may have to roll the money into a Roth IRA unless you can keep it in the existing plan.
Planning Changes to Your 401(k) Retirement Account
Your decision may be time-sensitive because, if you take a distribution from your existing plan, you have 60 days to roll it into a new qualified plan. Otherwise, you would face tax consequences.
It’s best not to rush this kind of decision. So, as soon as you think you might be leaving your employer, you should start looking into your options. That’s important whether you are fully retiring, semi-retiring or simply changing jobs.
Weighing your options as soon as you know you will be making a change will give you time to do your research and work with a financial advisor toward the best outcome.
Frequently Asked Questions
Q: How do I invest my 401(k) when I am only a few years away from retirement?
Investing is often about striking a balance. That balance includes working out the trade-off between near-term and long-term needs, as well as understanding how your 401(k) money can complement your social security benefits. Here’s what you should take into account in striking the right balance:
You might assume that being a few years from retirement equates to a fairly short investment horizon. However, your actual time horizon is probably closer to 25 years than two years.
You will need to invest for your probable life span, and that is long enough for inflation to significantly erode the value of your holdings if you don’t retain a growth element to your portfolio. Therefore a blended stock and bond portfolio is probably more appropriate for you than shifting completely to stable income investments.
Note that, even if you leave your company’s 401(k) plan when you retire, you can roll the money over into an IRA. Traditional IRAs allow you to maintain similar tax treatment to a 401(k) and thus delay the point where you have to pay taxes on your retirement savings.
One thing that impacts your time horizon is how quickly you withdraw money from your retirement plan. Try to draw down your retirement assets at a slow enough pace for them to last at least as long as your likely lifespan. If you need to draw down those savings more quickly, it effectively shortens your investment time horizon and that means you should be more conservatively invested.
Be advised that if you withdraw a fixed dollar amount every year, as your savings draw down, that dollar amount will become a progressively larger percentage of the remainder. That means that the pace of depletion will accelerate. This is another reason to try to limit how much you take out every year.
Note that, even if you reach a point where you have to make required minimum distributions from your retirement plan, you don’t have to spend all of those distributions as you take them. You can keep the money invested in an after-tax investment portfolio, perhaps setting it up in CDs structured to provide you with liquidity to live off at regular intervals.
Social security strategy
If social security is able to meet a meaningful portion of your post-retirement expenses, then it effectively behaves like an income-producing investment and allows you to invest your other retirement savings a little more aggressively.
However, if you retire at 62, you will have to decide whether to settle for smaller social security payments by beginning to draw them at that point or to delay taking social security in favor of larger payments down the road. You should make this decision before deciding how to adjust your 401(k) investments. If you decide to delay taking social security, it could mean drawing more heavily on your retirement plan savings in the interim, suggesting a more conservative stock/bond blend is appropriate.
Q: For 401(k) plans, how do I go about choosing the right one for me?
A: Because 401(k) plans are offered through employers, the first step is to find out what your employer has available. Different plans offer different investment options, plus you’ll want to familiarize yourself with other provisions of the plan, such as a company match. The company match is important–not all plans have one, but those that do will match some portion of your contribution to the plan. Taking full advantage of the company match is probably the easiest way to boost your retirement savings.
As for investment options, they can range anywhere from the equivalents of ordinary savings accounts to complex commodity or international investment vehicles. As a general rule, the closer you are to retirement, the more you should lean toward the savings-account end of the spectrum, but people’s circumstances and risk tolerances differ. The best way to start selecting investment options is to make a fundamental choice between two types of vehicles:
Asset allocation options: These include multiple asset classes, with the option’s investment manager allocating those asset classes according to a target retirement date or other general objective. These are good choices if you’d rather have a professional handle the crucial asset allocation decisions.
Individual asset class options: These allow you to individualize your asset allocation more precisely, but because of the difficulty of asset allocation decisions, taking this approach only makes sense if you feel you have a sufficient investment background to make those decisions.
Q: After my father passed my sister took charge of his savings accounts and things went missing or weren’t accounted for. For example, I found notations in a journal from 1994 about an IRA, but there was no sign of this account after my father died. There were no required minimum distributions being deposited into his other accounts, so I’m assuming it was a Roth IRA. Any advice on how to track this account down?
A: Unfortunately, this type of situation is all too common – both incomplete records left behind when a person dies, and mistrust between siblings about their involvement in their parents’ finances. At this point, there would only be two possible leads to pursue to find old IRA accounts, neither of which has a huge possibility of success. However, this is also an opportunity to make some more general comments about preparing for the transition of retirement assets into an estate.
How to track down an old IRA account
Your thought about the Roth IRA is understandable because these accounts do not mandate required minimum distributions while traditional IRAs do. However, since the reference to the account is from 1994, it cannot be a Roth IRA. These did not come into existence until 1997. Assuming your father had reached the age where he was required to make minimum distributions from a traditional IRA, it is entirely possible that deposits were made into an account you are not aware of, given that you believe there is information missing from your father’s records.
Ask for bank records
As for tracking this old IRA account down, one possibility would be to ask the bank specifically to look at their account transfer records. When IRA accounts are moved, they are typically transitioned directly into a new IRA at another institution in order to avoid tax consequences. The bank may still have a record of this kind of institution-to-institution transfer. Though if this happened all the way back in the 1990s, the current data system might not have records dating back that far.
Look at tax forms
Another possibility would be to look at your father’s tax records. IRA trustees are required to provide the owner of an IRA and the Internal Revenue Service with an annual Form 5498 that includes the market value of the IRA and amounts of any contributions and required minimum distributions that took place during the year. This form also includes the trustee name and the account number, so if you can find this form among your father’s tax records, it might help you track down the old IRA account.
Safeguard the transition of retirement assets to heirs
As some final notes for yourself and others when it comes to planning for your own estates:
Have an independent executor. It helps to have an independent executor (i.e., someone who is not a beneficiary of the will) and to periodically give that executor an updated list of account information.
Families should communicate about financial affairs as a group. That way, everyone is privy to the same information, so there is less possibility of things being done in secret.
Q: How long do I have to roll an IRA CD over from one institution to another?
A: You have a 60-day period from when you receive an IRA distribution to roll it over into another IRA. It is very important to adhere to this time frame, because if you do not the distribution will be exposed to income taxes, and possibly to a 10 percent penalty for early distribution.
You can eliminate the risk of exposing your rollover to taxes by moving your IRA via a trustee-to-trustee transfer instead. Technically, this is not even a rollover; at your instructions, your current trustee would transfer your IRA balance to another qualified trustee without the money ever passing through your hands.
Before making any kind of transfer or rollover, you should take the opportunity to comprehensively evaluate the status of your IRA. Here are some of the issues involved:
Check your current CD renewal date. Coordinating a transfer with the expiration of your current CD will help you avoid a possible penalty for early withdrawal from that CD.
Re-evaluate the role of your IRA. Before you choose what to do with your IRA next, you should make sure you have a clear objective in mind for this money. Are you close enough to retirement age that you expect to be tapping into this money soon, or are you tying to grow it for the long term? Is this your primary source of retirement funding, or is it a complement to other retirement assets?
Decide on the right vehicle and term for your next investment. The above analysis should inform what you do with the money next. While CDs should earn you more than money market accounts or savings accounts, they are not the best growth vehicle if you are several years away from retirement. If you do opt to stay in a CD, decide how long a term you want, remembering that the best CD rates will typically be found in longer-term CDs.
Shop around. Once you are clear on what you want, you can shop around for the right provider, whether this involves pursuing the best CD rates or the most appropriate long-term investment expertise.
Review your ongoing contributions. Once you have decided what to do with your current IRA balance, don’t neglect to continue making new contributions to the plan. You must also decide how these new contributions should be invested.