With the average person working for 12 companies over the course of a career, job hopping is the new normal for today’s workforce. Decreased loyalty to an employer has many side effects, which include more time spent looking for another job, the time and cost of transitioning across employers, updating your skill set, and managing the transfer of portable benefits such as a 401K.
Retirement plans vary based on the sector and the size of the company. For example, private, government, and non-profit employers offer different retirement plans,.401Ks are the most common among large private companies. More than 80% of private firms employing over 500 people, offer 401k retirement plans, giving 79% of the workforce access to tax preferred accounts.
Unlike most insurance policies, workers maintain ownership and control of retirement plans. You must take steps to ensure you preserve the tax benefits.
When a 401K exists with a former employer, you have the following options:
Leave the account in place. Accounts which meet the minimum balance requirements can typically remain with your previous employer. In this case, your investment selection will remain intact, and the account will grow based on the investment selections. The key advantage to inaction is doing nothing, leaving everything unchanged including the account tax benefits.
The downside is you must establish a new account with your new employer, leaving you to manage multiple accounts. You can no longer contribute to the old 401K, and in some cases, there are restrictions to account access and changing investment funds. To avoid taxation, you must repay any outstanding loans within 60 days, and company stock may require a vesting schedule to gain ownership.
Transfer 401K funds to a new account with your current employer. Most 401K plans allow for the conversion of an old 401K. The process typically involves selling the funds from the old account, and converting it to cash. The administrator then forwards the funds directly to the new 401K. A direct transfer has no tax consequences, and you gain access to the new employer’s fund selection, research tools, and account benefits, which could include borrowing capacity.
The primary advantage of transferring the account to the new 401K is the simplicity of maintaining a single retirement account. 401K's also allowed employees to borrow against the account and offer more protections against creditors than IRAs. When working past 70 ½, you can delay required minimum distributions (RMDs), as long as you remain on the job.
The downside to transferring funds to a new employer is you have limited investment options, set by the employer, which could include higher fees and fund expenses than the IRA alternative.
Transfer 401K funds to a Traditional IRA. Known as a rollover, converting 401K dollars to IRA funds, offers the same tax benefits, and is a tax-free conversion when you complete a custodian to custodian transfer, meaning the funds are deposited directly into the IRA account, without you receiving the money. You can choose a broker as the custodian allowing you to compare both prices and services across private firms, giving you more control over account costs.
You also have the option of receiving a check, with 60 days to redeposit the money. Employers sometimes require the deduction of taxes. In this case, you must replace 100% of the account value at the time of the transfer to prevent taxation.
Investment choices expand greatly in an IRA where you can choose among mutual funds, ETFs, stocks, bonds, and other market investments. You may also choose more non-traditional resources such as real estate, hedge funds, FOREX and other alternative investments. Due to the extensive fund selection, you gain more control over fund expenses as well as the overall portfolio risk.
While an IRA may require you to maintain a work and personal account, you can roll multiple 401Ks into a single IRA account, as well as your own annual contributions if you choose.
The IRA option allows you to keep your current investment selection or convert the funds to cash and choose new investments.
The downside of an IRA is the lack of loan access and the lower level of protections against creditors. In most cases, creditors cannot touch IRAs in bankruptcy, but could in the case of a civil judgment.
Transfer from traditional 401K to a Roth IRA. Roth conversions sacrifice the tax deferred treatment of the traditional 401K, in exchange for tax-free growth over the life of the account. You may convert any amount you wish over any time frame, giving you control over the additional taxation of transferred funds. Roth accounts require you to leave funds in the account for five years and have no mandatory withdrawals at 70 ½. You may also remove contributions at any time, although you must wait until 59 ½ before removing earnings, to avoid a penalty.
Like traditional IRAs, you lose the ability to borrow against the funds and have fewer protections against creditors than 401Ks provide.
Characteristics of Retirement Accounts
All designated retirement accounts feature tax benefits which are either tax-deferred or tax-free.
Tax deferred accounts give you an upfront tax benefit by lowering taxable income. Traditional IRAs and most 401K and work accounts fall into this category.
Tax-free growth does not provide an immediate tax benefit, but you gain tax-free growth and withdrawals in retirement. Roth accounts offer this benefit through an IRA, Roth conversion, or 401K.
Funds must remain in the account until you are 59 ½, to achieve the full tax benefit of an account. There are limited exceptions that will waive the 10% penalty, but not the taxation of withdrawn funds.
Choosing the Best Option
Review the investment selection from previous and current employers, compared to IRA options to determine which account best meets your needs. Also, equating the total cost of maintaining each account and the potential taxation of withdrawal or Roth conversion.