- August 29, 2024
- Financial Synergies Wealth Advisors
Between high contribution limits, tax advantages, and potential employer matching, a 401(k) can be a homerun for your retirement savings.
But if you’ve moved on from your 401(k) employer or are planning a transition soon, do you feel prepared to handle your retirement plan?
Do you know your 401(k) options? Consider these for managing your 401(k) savings after you leave your employer:
Keep your current 401(k)
Logistically, this is your easiest option – unfortunately, some employers don’t offer this once you’ve left. It’s best to check with your HR department to understand what’s available. Here are the pros and cons of doing so:
Pros
- Tax-Deferred Growth: Keeping your 401(k) with your former employer allows your savings to continue growing tax-deferred, which can enhance your retirement savings over time.
- Creditor Protection: 401(k) plans generally offer strong protection from creditors, which might not be as robust with IRAs.
- No Immediate Action Required: If you have more than $7,000 in your account, you can leave it indefinitely without being forced to make a decision, allowing you time to consider your options.
- Familiarity with the Plan: If you are satisfied with the investment options and fees of your former employer’s plan, it might be convenient to leave your 401(k) where it is.
Cons
- No Further Contributions: You cannot make additional contributions to a 401(k) held with a former employer, which limits the growth potential from new investments.
- Potential Neglect: Accounts left with former employers can become “out of sight, out of mind,” leading to less frequent monitoring and management.
- Possible Higher Fees: Some former employer plans may have higher fees compared to new employer plans or IRAs, which could erode your savings over time.
- Limited Investment Options: You might have fewer investment choices compared to rolling over into an IRA, which can offer a broader range of investment options.
Rollover to a new 401(k)
If your new employer offers a 401(k) plan, you can likely rollover your existing plan. This option has several advantages and disadvantages. Here’s a brief overview:
Pros
- Ease of Management: Consolidating your retirement accounts into one can simplify management and tracking, making it easier to monitor your overall financial picture.
- Employer Match: If your new employer offers a matching contribution, rolling over can allow you to take advantage of this benefit, effectively increasing your retirement savings.
- Tax Benefits: A direct rollover to your new employer’s 401(k) can help you avoid immediate tax implications, maintaining the tax-deferred status of your retirement savings.
- Loan Options: Some 401(k) plans allow you to borrow against your account, which might not be possible if your funds remain with a former employer.
- Rule of 55: If you leave your job in or after the year you turn 55, you can withdraw funds from your current employer’s 401(k) without penalties, which might not apply to old plans.
Cons
- Limited Investment Options: Your new employer’s plan might offer fewer investment choices compared to an IRA or your previous employer’s plan, potentially limiting your ability to diversify.
- Potentially Higher Fees: The fees associated with your new employer’s plan could be higher than those of your previous plan, impacting your overall returns.
- Less Control: Rolling over to a new employer’s plan may reduce your control over investment choices and strategies compared to other options like an IRA.
Rollover to an IRA
Rolling your 401(k) into an IRA after leaving a company can be a strategic move that provides you the most flexibility over the long run. Here is a brief summary:
Pros
- Wider Investment Options: IRAs typically offer a broader range of investment choices compared to 401(k) plans, including individual stocks, bonds, mutual funds, ETFs, and alternative investments like real estate or private equity.
- Tax Benefits: Rolling over to an IRA allows you to maintain the tax-deferred status of your retirement savings, avoiding immediate taxes and penalties associated with early withdrawals.
- Simplified Management: Consolidating multiple retirement accounts into a single IRA can simplify recordkeeping and make it easier to manage your retirement savings.
- Potential for Lower Costs: Depending on the provider, IRAs may offer investment options with lower expense ratios compared to some 401(k) plans, potentially reducing overall costs.
- Flexibility in Withdrawals: IRAs may offer more flexible withdrawal options, such as penalty-free withdrawals for certain expenses like education or first-time home purchases.
Cons
- Creditor Protection: 401(k) plans generally offer stronger protection against creditors compared to IRAs, which can vary by state.
- No Loan Options: Unlike some 401(k) plans, IRAs do not allow you to take loans against your retirement savings.
- Potential Fees: While IRAs can have lower investment costs, they may also come with management fees that could be higher than those in a 401(k) plan.
- Complexity in Roth Conversions: If you plan to make backdoor Roth IRA contributions, having a traditional IRA balance can complicate the process due to the pro-rata rule.
Withdraw your money
This might be the least desirable option. Withdrawing your 401(k) after leaving an employer can provide immediate access to cash, but it comes with significant drawbacks. Here’s a brief overview of the pros and cons:
Pros
- Immediate Access to Funds: Withdrawing your 401(k) provides you with immediate liquidity, which can be helpful if you are in urgent need of cash for expenses or emergencies.
- No Account Management: Once you withdraw the funds, you no longer have to manage the account or worry about investment decisions related to that 401(k).
Cons
- Taxes and Penalties: If you withdraw your 401(k) before age 59½, you will typically face a 10% early withdrawal penalty in addition to ordinary income taxes on the distribution. This can significantly reduce the amount you receive.
- Loss of Future Growth: Cashing out your 401(k) means you lose the potential for future tax-deferred growth, which can substantially impact your long-term retirement savings.
- Reduced Retirement Savings: Withdrawing from your 401(k) diminishes your retirement savings, potentially jeopardizing your financial security in retirement.
Overall, withdrawing your 401(k) is generally not recommended unless you have no other financial options, due to the immediate tax implications and the long-term impact on your retirement savings.
Conclusion
Ultimately, the action you take on your 401(k) plan should be based on your personal financial situation, and your long-term investment strategy.
Navigating your 401(k) is just the tip of the iceberg in retirement planning—there’s a whole world of strategies waiting to empower your future preparations. Just know we’re here to help you with all aspects, from 401(k) to tax management.
Sources:
https://www.bankrate.com/retirement/8-tips-on-moving-401k-after-leaving-job/
https://smartasset.com/retirement/should-i-roll-over-my-401k
https://www.ellevest.com/magazine/retirement/401k-when-you-quit
Concerns or questions about your retirement plan? Contact Financial Synergies today.
We are a boutique, financial advisory and total wealth management firm with over 35 years helping clients navigate markets and developing custom financial plans. To learn more about our approach to financial planning please reach out to us. One of our seasoned advisors would be happy to help you build a custom financial plan to help ensure you accomplish your financial goals and objectives. Schedule a conversation with us today.
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