So, the winds of change have blown through your life and you’ve left your job. When the dust settles, one thing you should think about is what to do with your old retirement plan.
If you have questions, you’re not alone. People are changing jobs so frequently that I’m getting this question as often as I lose to my kids at video games — it’s a lot!
The great thing about this decision is that you have choices! For someone not yet retired, you can typically:
- Roll over the funds to a traditional or Roth IRA. Caution: Rolling over to a Roth IRA will likely create a taxable event.
- Leave the funds in the old plan (usually permitted only if the dollar amount is above a certain limit).
- Roll over the funds to a new employer's retirement plan (if the new plan allows).
Of course, you could cash out your plan, pay the taxes and penalties and do what you wish with the funds. However, I would strongly discourage this — not only because of the taxes and potential penalties but also because of the retirement funding damage it could cause. So, I'll focus the rest of this post on the choices of rolling over to an IRA or sticking with an employer plan (either your old plan or a new employer plan).
Roll Over to an IRA
Here are a few reasons you might consider rolling over an old employer-provided plan to an IRA:
- Investment flexibility. In some cases, the investment choices in your old plan may not include everything you’d like to have available. Rolling the money into an IRA could open up more options.
- Better Organization. Maintaining the right mix of investments can be challenging when assets are spread among numerous financial institutions. This also can make it hard to understand how the various investments relate with each other. Consolidating accounts can simplify your monitoring and rebalancing efforts. It also may provide the opportunity for professional management.
- Less paperwork. Portfolio maintenance is more difficult when retirement accounts are at multiple institutions, so naturally, keeping track of all of the paperwork is harder, too. Consolidating will streamline this process.
Stick With an Employer Plan
Of course, there also may be good reasons to leave your money in your old plan or roll it to a new employer plan:
- Investment choices. Some employer plans offer guaranteed products that aren't available elsewhere. If your old or new employer’s plan has such choices and they’re important to your overall portfolio, it may make sense to go this route.
- Fees. In many cases, the investments available in company retirement accounts will have lower fees than investments you might select inside an IRA. You should weigh this point if you’re considering a rollover to an IRA.
- Accessibility. Will you need the funds soon after turning 55? You can begin taking withdrawals from most employer plans without tax penalties when you leave your job at age 55 or older. A traditional IRA, on the other hand, does not typically allow penalty-free withdrawals until age 59½.
The right answer comes down to your specific situation, goals and priorities.
A Word of Warning
I get nervous when people try to make this decision on their own. Too often the decision is based on which approach will cost the least or be the easiest. While I’m all for low cost and ease, this decision requires more than that. You need to find a retirement investment plan that balances your old plan and your new situation. So let me leave you with one final note of caution: Don’t make this choice by yourself unless you’re certain your old plan and new reality will mesh. Get help if you need some assistance to make the right decision for you.
After all, you don’t want to get blown off course for your future by those winds of change.
Withdrawals from a retirement plan made before age 59½ may be subject to a 10% federal penalty and ordinary income taxes.
If you receive a check made out to you, your former employer is required to withhold 20% of the total amount. When you deposit the check into your IRA, you must make up that percentage from your own resources. At tax time, you can apply to get the withheld 20% back, but it could take some time. A better approach is to roll the money over (known as a Direct Rollover) without ever receiving it directly.
Traditional IRA distributions are taxed as ordinary income. Qualified Roth IRA distributions are not subject to state and local taxation in most states. Qualified Roth IRA distributions are also federally tax-free, provided a Roth account has been open for at least five years and the owner has reached age 59½, or meets other requirements.
Other options are available besides rolling over your employer sponsored retirement plan, and an employer sponsored retirement plan can offer advantages investors can't get if they roll the money into an IRA.
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