Distribution Options

 

Switching jobs? Here are your 401(k) options

It is a well-known fact that the Average American worker switches jobs several times throughout their career. As you change jobs you may question: “What happens to my 401k?” Below is a list of the four options you have when leaving your employer. Please be sure to read the general implications of each option and the special tax notice you received upon leaving your employer. And most importantly, be sure to consult your tax or legal advisor before making any decisions.

1. Keep the funds in the plan

You need to consult the Summary Plan Description (SPD). However, below are the typical options regarding leaving your funds in the plan based on your vested balance:

a. Less than $1,000 – You may be automatically cashed out of the plan in the form of a check. The total amount you receive will be net of the 20% tax withholding required by law. However, you may pay even more in taxes since you are responsible for income taxes and potentially a 10% penalty (if you are under age 59½).

b. Between $1,000 and $5,000 – Employers may have the option to automatically roll your funds into an IRA with a pre-determined fund company.

c. Over $5,000 – If you are happy with the current investment options available you may leave your funds with the plan. When choosing this option, you should also consider plan expense fees, ease of continuing to manage your investment options, withdrawal options, and your overall portfolio allocations when combined with other outside retirement funds.

At some point, you may want to opt for one of the other options listed below:

2. Transfer the funds to your new employer’s plan.

You must first consult your current employer’s SPD to see if the plan allows it. Forms will be required from both your previous and current employer. You will be required to obtain the required forms from your previous employer to solicit the funds. The best way to move the money is through a trustee-to-trustee transfer.

3. Roll over the funds to an IRA.

Another way to avoid taxes and penalties is to roll the funds into an IRA. Upon distribution you will have 60 days to roll your money from your previous employer to an IRA. If rolling into an IRA is the option you plan to use, it is best to request a trustee-to-trustee rollover with the check made out to the IRA custodian for the benefit (FBO) of you. This will avoid the 20% withholding. And if done within the 60 day time frame there are no IRS tax or penalty implications on the transfer.

4. Take the funds as a cash distribution.

The last and final resort option should be taking the funds in cash. This option can be costly since it is subject to taxes AND may be subject to a 10% penalty (if you are under age 59½). And depending on your tax bracket, you could lose up to almost half of your balance to the IRS. Another important item to note is that if you decide to take a cash distribution, the plan will withhold 20% for taxes. If you then later decide, within that 60 day window, to use the funds to open an IRA, you will be responsible for the cash to bring the IRA contribution to the full amount. When you file your tax return you will get a credit for the 20% previously withheld. In an extreme case of financial emergency, you should cash out only what you need and roll the remaining balance into an IRA or your employer’s plan to avoid taxes and penalties on the entire amount.