You recently left an employer where you were contributing to their 401(k), 403(b), or some other qualified retirement plan. Now what? This article will outline your options and point out some pros and cons of each option.
Option 1: Leave the funds in the former employer’s plan
You can leave your savings in the old plan if its terms allow it. While most plans will let you do this, that is not always true. Many plans will automatically roll your savings into an IRA if it is under a certain balance. They stipulate this in the plan’s description, but most people do not realize that, and trying to track down the IRA becomes a burden. Here are some pros and cons of this option:
Pros:
1) Continued investment and growth potential in a tax-deferred account.
2) If you leave the employer in the year you turn 55 or older (50 or older for certain public safety employees), you can take distributions from the plan without having to pay the 10% IRS tax penalty that would typically be imposed for taking a distribution before 59 ½. Keep in mind this only applies to CURRENT plans. This rule no longer applies if you start contributing to a new employer plan.
3) Generally lower fees and expenses than an IRA.
Cons:
1) Not all employer plans allow funds from former employees to remain in the plan. They could roll it to an IRA as mentioned previously, OR if it is under a certain amount, they could even force it out by sending you a check, and then you are hit with the taxes and penalty.
2) Leaving behind savings in old plans increases the probability of losing track of them.
3) Limited to the investment options available in the plan only.
4) You will no longer be able to contribute to the plan after your termination.
Option 2: Roll funds from the employer plan into an IRA
An Individual Retirement Account (IRA) is a tax-deferred investment vehicle that allows you to invest in marketable securities. An employer does not sponsor an IRA. If you hire an independent fiduciary advisor, like Whitaker-Myers Wealth Managers, we can help you with the rollover process and build a portfolio that fits your needs and risk tolerance to achieve your goals. We can also ensure you avoid common mistakes people make when attempting a rollover independently. Here are the pros and cons of rolling your funds into an IRA:
Pros:
1) More investment options than an employer-sponsored plan.
2) Gives you the ability to consolidate other tax-deferred accounts into a single IRA.
3) Option to have your IRA managed by one professional.
4) Ability to make additional contributions.
5) Continued tax-deferred growth potential.
6) If appropriately executed, there are no tax consequences or penalties to rollover from an employer plan to an IRA.
Cons:
1) Fees and expenses might be higher than an employer-sponsored plan.
2) High-income earners may lose the ability to make deductible contributions to an IRA or to contribute to a back-door Roth IRA.
Option 3: Withdraw the funds from the employer plan
Another option is to take a partial or full distribution from the plan. This is generally not wise, especially if you are under 59 ½. Here are a few pros and cons of cashing out your savings:
Pros:
1) Immediate access to your money.
2) If applicable, the rule of 55, as discussed in the previous option.
Cons:
1) All withdrawals are subject to a mandatory 20% federal tax withholding. State and local taxes may apply too.
2) If you are under 59 ½ and do not qualify for the rule of 55, an additional 10% tax penalty may be imposed on your distribution.
3) The funds will no longer have tax-deferred growth potential.
Option 4: Roll funds from the old employer plan to a new employer plan
This option is not always available. Employers are not required to allow funds from previous plans or IRAs into their sponsored plan. While this is not the worst option, it does come with its pros and cons:
Pros:
1) Continued tax-deferred growth potential.
2) Consolidation of assets makes it easier to keep track of savings.
3) Ability to invest in securities available in the plan.
4) No tax consequences or penalties rolling from one plan to another.
Cons:
1) Limited to the investments available in the plan.
2) Fees and expenses might be higher than the previous plan.
Conclusion
This article is for informational purposes only and should not be taken as advice or a recommendation. Several other factors may affect which of these options is best for you. If you have funds in an old employer plan or want to consolidate accounts, we suggest contacting one of our team's financial advisors. Going through a financial plan might be the best way to find out which option would be best for you. Our advisors would be happy to do that and they will answer any questions to make this a seamless process for you.
Employer-Sponsored Retirement Plan Options and Considerations for Terminated Employees
September 1, 2023
Kelly Kranstuber
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