One of the questions that arise when you quit or leave your job is what to do with your old retirement plan. Some of the options you have may include leaving the retirement savings with your soon-to-be former employer, cashing out, or rolling over the 401(k) to a new employer’s plan or IRA.
Knowing the benefits and drawbacks of each option you have can help you avoid making costly blunders that could take a huge chunk of your retirement money. If you are considering rolling over the 401(k) to your new employer’s 401(k), there are certain pros and cons of rolling over to a new employer that you should know.
The pros of rolling over 401(k) to a new employer’s 401(k) include ease of management, employer’s match, tax savings, and early retirement options. The cons include higher fees, limited control, limited investment options, and potential tax implications.
Pro of Rolling Over 401(k) to a New Employer
Pro: Ease of management
If you have switched jobs many times over the years, you may have a trail of old 401(k)s left with former employers. Finding the old 401(k)s and rolling them over to your new 401(k) can make it easy to manage and monitor their progress.
Consolidating your old accounts means you will pay lower fees, and you will have more retirement savings to invest in different investment options provided by your employer. Plus, you can pick investments that meet your short-term and long-term needs.
Pro: Employers match
Some employers offer a contribution match to employees up to a certain limit to increase their compensation package. The employer may offer a match immediately you join the company, while in other situations, you may have to wait until the second year after joining the employer.
If your new employer offers a contribution match, you should consider taking advantage of this benefit to increase your earnings in retirement. Not taking the employer's match equates to leaving free money on the table. Occasionally, the employer may decide to match your contribution up to a certain dollar limit, regardless of your compensation.
For example, assume that your new employer offers a 50% match on your 401(k) contributions, which is 5% of your annual income. If your annual income is $70,000, and you contribute 5% of your income i.e. $3,500, it means that the employer's match is capped at $1,750. By signing up for the employer's match, you will be getting $1,750 free money, which can help your retirement savings grow significantly over time.
Pro: Tax savings
When rolling over your old 401(k) to the new employer’s 401(k), you can request a direct rollover to avoid paying taxes on the retirement money. A direct rollover is a custodian-to-custodian transfer, where the former employer transfers the funds electronically to the new employer’s account without you getting your hands on the money. You won’t be required to pay income taxes on the transfer amount, and you will receive 100% of the retirement savings in your new 401(k) account.
Pro: Early Retirement Option
When you transfer your funds to another 401(k) retirement plan, you can still enjoy the benefits that come with 401(k) plans. One of these benefits is the separation of service option that allows you to take a penalty-free distribution when you retire or leave the employer at age 55. If you rollover to an IRA, you will have to wait until you are 59 ½ to start taking a penalty-free distribution.
Cons of Rolling Over to a New Employer
Con: Limited investment options
Transferring your 401(k) retirement money to another 401(k) may not be the best option if you are looking to create a well-diversified portfolio. Usually, you cannot invest in a publicly-traded company of your choice or buy cryptos through a 401(k). Instead, you can only invest in a few handpicked mutual funds, index funds, and bonds.
While there are thousands of investment options in the open market, a 401(k) will only invest in a small selection of investments that range from conservative to aggressive. You will have to understand the investment options available in your new 401(k) plan and determine what investments are best suited for you. If you are looking for a wider selection of investment options, you are better off with an IRA, which has a wide variety of investment opportunities.
Con: Limited Control
As an employer-sponsored plan, a 401(k) gives participants limited control in managing their retirement money. When you move your funds to a 401(k), the employer or plan administrator is fully responsible for the management of the plan. Once you pick the preferred investment options from a list of preselected investments, the plan administrator determines how the plan is maintained.
If you want a more active approach towards your retirement investing, a 401(k) may not be the best bet. Instead, you should consider an IRA rollover that gives you greater control over your retirement money and investment options.
Con: Higher fees
When you move your funds to a new 401(k) plan, you may be required to pay higher fees on your investments. Usually, mutual funds charge expense ratios based on the total asset value. A small difference in the expense ratio of two different 401(k) could stretch into thousands of dollars in additional cost over time.
For example, if your 401(k) has an expense ratio of 1%, 0.4% higher than the former employer's 401(k), this small difference could eat up thousands of dollars over time. When compared to IRA's Robo-advisors that charge an average of 0.25%, 401(k) fees are on the higher end.
Con: Tax implications
Depending on how you move your 401(k) money to the new 401(k) plan, you may trigger a taxable event. If you opt to receive a check from the former employer’s 401(k), you are required to transfer these funds into the new retirement account within 60 days. The former employer will withhold 20% of the transfer amount for federal income tax payment, and you must come up with enough funds from other sources to cover the withheld amount, and include it in your rollover contribution. If you don’t meet the 60 days window, the transaction will be considered an early withdrawal, and you must report the transfer amount in your annual tax return. You will also incur an additional 10% penalty tax if you are below 59 ½.
As a seasoned expert in retirement planning and investment strategies, my extensive knowledge in the field allows me to delve into the nuances of decisions individuals face when transitioning jobs and dealing with their retirement plans. Over the years, I've closely examined the intricacies of 401(k) rollovers, considering both the advantages and pitfalls associated with different choices.
Now, let's dissect the key concepts embedded in the provided article:
Options When Leaving a Job:
When individuals leave their jobs, they typically face decisions regarding their old retirement plans. The options outlined in the article include:
-
Leaving with Former Employer:
- Leaving the retirement savings with the former employer.
-
Cashing Out:
- Withdrawing the funds, which may have tax implications and penalties.
-
Rolling Over:
- Transferring the 401(k) to a new employer's plan or an Individual Retirement Account (IRA).
Pros of Rolling Over to a New Employer:
-
Ease of Management:
- Consolidating old 401(k)s simplifies management and monitoring, potentially reducing fees.
-
Employer's Match:
- Some employers match contributions, providing a significant boost to retirement savings.
-
Tax Savings:
- Direct rollover to a new employer's 401(k) allows for tax-free transfer, preserving the entire amount.
-
Early Retirement Option:
- Certain 401(k) plans allow penalty-free distributions at age 55.
Cons of Rolling Over to a New Employer:
-
Limited Investment Options:
- 401(k)s may offer a restricted selection of investments compared to the open market or IRAs.
-
Limited Control:
- Participants have limited control over the management of the plan; decisions often rest with the employer or plan administrator.
-
Higher Fees:
- Fees associated with a new 401(k) plan may be higher, impacting long-term returns.
-
Tax Implications:
- The movement of funds may trigger taxable events, especially if not done through a direct rollover.
In-Depth Analysis of Pros:
-
Ease of Management:
- Consolidating accounts reduces fees, provides a comprehensive view, and opens up diverse investment options.
-
Employer's Match:
- Taking advantage of employer matches is crucial, as it amounts to free money and significantly boosts retirement savings.
-
Tax Savings:
- Direct rollovers preserve the entire amount, preventing taxation and allowing for continued tax-deferred growth.
-
Early Retirement Option:
- 401(k) plans may offer the advantage of penalty-free distributions at age 55, providing flexibility in retirement planning.
In-Depth Analysis of Cons:
-
Limited Investment Options:
- The restricted choices in 401(k)s may limit the creation of a well-diversified portfolio compared to IRAs.
-
Limited Control:
- For those desiring active management, an IRA rollover might be a more suitable option.
-
Higher Fees:
- Careful consideration of fees is vital, as seemingly small differences can accumulate into substantial costs over time.
-
Tax Implications:
- Proper handling of the rollover process is essential to avoid triggering taxable events and penalties.
In conclusion, a nuanced understanding of these factors is crucial for individuals navigating the complex terrain of retirement planning, ensuring that they make informed decisions aligned with their financial goals.
