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401(k) Mistakes from Switching Jobs

401(k) Mistakes from Switching Jobs

| July 19, 2023

Research shows that the average American employee switches jobs 12.3 times before retiring.1 WOW!

Changing jobs can mean that many of us have old 401(k) plans, which may not be properly positioned to help prepare for retirement. When changing jobs, you have some choices to make about your old 401(k). Generally, there are four basic options:

  1. You can leave the assets in your former employer’s plan, if permitted.
  2. You can roll over the assets into your new employer’s plan if the plan accepts transfers.
  3. You can roll the assets over into an Individual Retirement Account (IRA).
  4. You can cash out your account (and manage the potential tax consequences).

Each of these choices has advantages and disadvantages to consider. In this article, you’ll learn how to avoid common (and expensive) mistakes and how your 401(k) can play a key role in your retirement preparations. Remember, you have at least 30 days to decide what to do with your 401(k) when you switch jobs.

  1. Staying Put

If you are happy with your former employer’s plan, you might consider leaving your account behind. It’s important to remember that you don’t give up the right to move your account to your new employer’s 401(k) or an IRA at any time. There may be restrictions on your money, however. For example, you may not be able to take a loan from the plan, or some employers might charge higher fees if you are not an active employee.  Also, you may not wish to maintain multiple accounts if you change jobs frequently.

Another thing to consider is a low balance 401(k).  In general, participants in a 401(k) with less than $5,000 can be forced out of a plan.  If you have less than $1,000, you employer could just cut you a check.  Simply put, if you have a low balance in a former employer 401(k), you may not have the option to leave it.  If you find yourself leaving a job with less than $5,000 in the 401k, you may want to make a concerted effort to get the money rolled into a new plan or an IRA as soon as possible.

  1. Taking Your Monies to Your New Job

One of the best arguments in favor of rolling over your old retirement plan is that it can help simplify your life. In our experience, investors tend to lose track of accounts that aren’t right in front of them. Life gets busy and failing to modify your investment strategies to keep up with your needs can undermine your long-term financial success. Putting your assets in one place can help ensure that your investments remain consistent with your financial goals.

If you are considering this choice, it’s important to look at your new employer’s plan before making the switch. First, check to make sure the new plan has the investment choices that you are looking for. Second, research and understand the fees associated with the new plan. And lastly, see when you are eligible to join the plan. In some instances, you must wait until the next enrollment period which could be months from your hire date.

3. Rolling 401(k) Assets into an IRA

You can elect to roll over your traditional 401(k) into a traditional IRA. To initiate the rollover, you’ll need to select an IRA provider and work with your 401(k) plan administrator. If the money is moved directly from your plan administrator to the IRA provider, no taxes are due on the assets that you move, and any new earnings accumulate tax deferred.

In recent years, Roth 401(k) plans have been provided by more 401(k) plan administrators. Rolling over your Roth 401(k) is a similar process to rolling over a traditional 401(k). If the money is moved directly, no taxes are due on the assets that you move, and any new earnings accumulate tax deferred.

Under the SECURE Act, once you reach age 72, you must begin taking required minimum distributions from a Traditional Individual Retirement Account (IRA) in most circumstances. Withdrawals from Traditional IRAs are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty.

To qualify for the tax-free and penalty-free withdrawal of earnings, Roth 401(k) distributions must meet a five-year holding requirement and occur after age 59½. Tax-free and penalty-free withdrawal can also be taken under certain other circumstances, such as the owner's death. Employer match is pretax and not distributed tax-free during retirement.

  1. Cashing Out

Another option is to liquidate your old plan and receive the money directly. While it can be tempting to see your 401(k) as a quick source of cash, cashing out may result in penalties and taxes.

 Your 401(k) plan administrator will withhold 20 percent of your current account balance to prepay the tax you’ll owe. Remember, your 401(k) was funded with pre-tax dollars. Your account will pay federal, state, and local taxes. Also, the IRS will consider your payout an early distribution, and may assess a 10 percent early withdrawal penalty. All combined, you may pay up to 50 percent of your account balance in penalties and taxes.

One of the benefits of working with a firm like ours is the comfort of knowing that you have a team of professionals continuously monitoring your investments and keeping you on track. As professionals, we take every aspect of your financial life into consideration when building customized strategies for your retirement.

If you're leaving your job to pursue other opportunities, the transition can be a stressful experience. Discussing your situation with a financial professional can help you relax and explore all your choices.