all about How To : Guide to Managing Retirement Accounts When You Leave a Job

Guide to Managing Retirement Accounts When You Leave a Job Katia A. says, “I’m 26 years old, make $38,000 a year, and plan to retire well, hopefully before I turn 60. I had a 403b at my previous job and am confused about what to do with it.

Should I do an IRA rollover with the same brokerage firm or a different firm, or transfer it to the 401k at my new job? Also, should I use a Roth or traditional retirement account?”

Thanks for your question, Katia. If you’re like most people, you’ll change jobs many times over the course of your career. One of the best features of a workplace retirement plan, such as a 403b or 401k, is that you can take your money with you when you go.

In this post, I’ll explain the pros and cons of four options for managing your retirement account when you leave a job for any reason. I’ll recommend the best move to make and explain the rules so you know exactly how to manage your retirement money for success.

Free Resource: Retirement Account Comparison Chart (PDF download) - get the rules for the most popular retirement accounts

What Is a Retirement Rollover?

Investing money through one or more retirement accounts is wise because they give you fantastic tax savings. Those savings allow you to grow a much larger account for retirement than you could by investing through a taxable, non-retirement account.

So, if you have a retirement plan at work but aren’t participating in it, now’s the time to enroll! Contribute as much as you can, even if it’s just a small amount. Make a goal to increase your contribution each year until you’re putting away a minimum of 10% to 15% of your pre-tax income.

And if you don’t have a retirement account at work or are self-employed, don’t worry. There are great retirement options for you as well. Read or listen to these posts to learn more:

Don’t make the mistake of thinking that once you leave a job with a 401k or 403b that you can’t continue getting retirement tax breaks. Doing a “rollover” allows you to withdraw funds from your old retirement plan and transfer them to another eligible retirement account.

When you roll over a retirement account, you don’t lose any contributions you’ve made or the investment earnings that may have accumulated over time. And if you’re vested, you don’t lose any money that your employer may have put into your account as matching funds.

The main rule with a retirement rollover is that once you start it, you must complete it within 60 days. If you miss this deadline and are younger than age 59½, the transaction is an early withdrawal, subject to income tax, plus an additional 10% early withdrawal penalty.

The main rule with a retirement rollover is that once you start it, you must complete it within 60 days.

If you’re a regular Money Girl reader or podcast listener, you already know that I generally don’t recommend taking early withdrawals from retirement accounts for any reason because they’re just too expensive.

If you complete a traditional rollover within the allowable 60-day window, you maintain the tax-deferred status of all the funds, until you take withdrawals in the future. And with a Roth rollover you maintain the tax-free status of your funds.

4 Options for Managing Your Retirement Account When You Leave a Job

Once you’re no longer employed by a company that sponsors your retirement plan, such as a 401k or 403b, you have several options to manage your money. You can use any of them no matter if you were terminated for cause, got laid off, resigned to take a new job, or left to become self-employed.

Here are 4 options for managing your workplace retirement account when you leave a job:

Option #1: Cash out the funds

Cashing out a retirement plan when you leave a job is the easiest, but worst option!

Cashing out a retirement plan when you leave a job is the easiest, but worst option! As I previously mentioned, taking an early withdrawal means you get hit with both income tax and a 10% penalty. Here’s what could happen:

Let’s say you have a balance in the account of $100,000 and decide to cash out. If your average rate for federal and state income tax is 30%, and you have an additional 10% penalty, you lose 40%. Cracking open your $100,000 nest egg could mean that you’re left with just $60,000, or even less, depending on how much you earn.

To find out how much cashing out early could damage your future retirement savings, check out the 401(k) Spend It or Save It? Calculator.

Option #2: Leave the funds in your old account

Most retirement plans allow you to keep money in the account after you’re no longer employed, as long as you meet a minimum account balance, which is usually $5,000. If you don’t have that much, the plan custodian typically has authority to deposit your money into an IRA in your name without your consent.

If your retirement plan has $1,000 or less, the custodian is allowed to automatically cash you out. They’ll withhold 20% for taxes (although you may owe more), file a form 1099-R to document the distribution, and pay you the balance. They simply don’t want the hassle of managing many small accounts for ex-participants.

The downside to leaving money in an old retirement account is that you can’t make any new contributions because you’re no longer an employee. However, the funds can continue to grow and you can manage them any way you like by selling or buying investments from a set menu of options.

The downside to leaving money in an old retirement account is that you can’t make any new contributions because you’re no longer an employee.

Leaving money in an old retirement plan is certainly better than cashing out and paying a huge tax bill, but it doesn’t give you as much flexibility as the next 2 options that I’ll cover.

I only recommend leaving money in an old employer’s retirement plan if the management and fund fees are exceptionally low. Just make sure that the plan doesn’t charge higher fees when you’re not an active employee.

Another reason you might want to leave retirement money in an old employer’s plan is if you’re unemployed or have a job that doesn’t offer a plan. I’ll cover some special legal protections you get in just a moment.

Option #3: Rollover the funds into a new workplace plan

If you do land a new job with a retirement plan it may allow a rollover from your old workplace plan, once you’re eligible to participate. The IRS allows you to rollover money into almost any type of retirement plan—check out their Rollover Chart. Katia could even rollover a traditional 403b into a traditional 401k.

However, retirement plans aren’t required to accept incoming rollovers. So you’ll need to check with your new plan administrator to see what’s possible. And remember that once you initiate a transfer, it must be completed within 60 days in order to avoid taxes and a penalty.

Here are the downsides to transferring money from one workplace retirement plan to another:

Having less flexibility compared to doing an IRA rollover, which I’ll cover next. For instance, you can’t take money out of a 401k or 403b until you leave the company or qualify for an allowable hardship.
There may be fewer investment choices or higher fees compared to an IRA, depending on the brokerage firm.

There are several upsides to consolidating workplace plans:

Having all your retirement savings in one account may make it easier to manage and track.
Retirees can begin taking penalty-free withdrawals from workplace plans as early as age 55.
Having a Roth account at work means you can make contributions no matter how much you earn—that’s not the case with a Roth IRA.
Workplace plans offer more legal protection compared to an IRA because they’re covered under the Employee Retirement Income Security Act of 1974 (ERISA).

The power of ERISA is that it doesn’t allow creditors, except the federal government, to touch your money. That means if you get into financial trouble and can’t pay a lender, they could sue you, but couldn’t take your 401k or 403b money to repay your debt. That may not be the case for money in an IRA, which I’ll cover next.

Option #4: Rollover funds into an Individual Retirement Arrangement (IRA)

The last option for your old workplace retirement plan is to roll it over into an existing or new IRA within 60 days. Your earnings in the account will grow tax-deferred, just like in your old workplace plan. And if you had a Roth 401k or 403b, you can roll it over into a Roth IRA.

Here are the main downsides to rolling over an old workplace retirement plan into an IRA:

Assets may not be protected from creditors through ERISA, the law that I previously mentioned, depending on the state where you live. So, if protecting your retirement from creditors is a concern for you, be sure to ask your existing or potential new IRA custodian about your state’s regulations.
If you’re a high earner, you won’t be eligible to make new contributions to a Roth IRA; however, it can continue to grow on a tax-free basis.

Here are the upsides to having an IRA:

Having the most flexibility and control because you choose the financial institution and your investments. You’ll have a full range of options—such as stocks, bonds, and exchange-traded funds—that are typically not included on the investment menu for a 401k or 403b.
Unlike with a workplace retirement account, there are situations when you can take money out of an IRA, before reaching age 59½, and avoid the expensive 10% penalty. Some exceptions include using IRA funds for medical expenses, college costs, and buying or building your first home. Just remember that you’ll still have to pay ordinary income tax on those withdrawals.

So, if you want more control over your investment choices, believe you may need to withdraw funds before retirement, or simply don’t have a new workplace plan to roll your account into, having an IRA is a great option.

Should You Choose a Traditional or Roth Retirement Account?

Katia asked if she should choose a traditional or Roth account. When it comes to rollovers, you need to have the same type of account. For example, if you have a traditional 403b, you must rollover to another traditional retirement account at work or to a traditional IRA.

If you move traditional, pre-tax funds into a post-tax, Roth account, that’s called a Roth conversion. I don’t recommend it because you must pay income tax on the full amount that wasn’t previously taxed.

Instead, you can open up a new Roth account at work or also make contributions to a Roth IRA. Roth accounts are most beneficial for younger workers who are likely earning less today than they will in the future.

Paying tax upfront on lower income is wise and then you enjoy tax-free withdrawals in retirement when you have higher income. So I’d recommend that Katia make Roth contributions to her new 401k, if it’s an option.

What’s the Best Place for Your Retirement Rollover?

To sum up, the best place for your old retirement account depends on the flexibility and legal protections you want, the quality of your old plan, your income, and whether you have a new retirement plan that accepts rollovers.

The goal is to position your retirement money where you can keep it safe and allow it to grow using low-cost, diversified investment options.

If you have questions about doing a rollover, go straight to your retirement plan custodian for advice. They can walk you through the process to make sure you don’t break the rules and end up with a botched rollover.

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all about How To

Rabu, 19 Oktober 2016

Guide to Managing Retirement Accounts When You Leave a Job