3 Points to Consider when Leaving a Job with a 401(k)

One of the common questions we get is, “What do I do with the 401(k) at my previous employer?” 

Unfortunately, there’s not a blanket answer that makes sense in every situation.  Ultimately, you have three options.  The first is to leave the funds in the current plan (as long as the plan allows it).  The second option is to roll the funds over into an IRA or into the employer-sponsored plan at your new employer (as long as the plan allows it).  Your third option is to take a distribution (which can come with hefty tax implications).  While the options may seem simple on the surface, this decision has many moving pieces.  We always recommend consulting with your financial planner and tax professional prior to pulling the trigger on your decision and of course, if you’d like some guidance on this topic, make sure to click here to schedule time with one of our planners.  In the meantime, we have compiled some of the basic points you should consider prior to your decision.

1. Your Age

One of the little-known 401(k) rules comes with the “55 and separated from service” rule.  It’s commonly known that when you distribute funds from a pre-tax qualified retirement plan prior to age 59 and ½, you incur a 10% penalty along with having to report the distribution as taxable income (unless you qualify for one of the unique exceptions – more on this in a later blog post).  However, the “55 and separated from service” rule allows you to take distributions prior to age 59 and ½ without incurring that nasty tax penalty.  So, how does it work?  There are two basic components.  First, you must separate from service with the employer that holds your 401(k) after your 55th birthday.  If you meet this criteria, you qualify for the rule.  The second criteria is that you can’t roll the funds out of the plan.  In order to qualify, the funds must stay in the 401(k).  This special rule can be perfect for someone who may be retiring at an earlier age – it provides incredible flexibility.  

If you aren’t age 55 (or are older than age 59 and ½), then the age consideration is much less of a factor.

2. Investment Options and Management Style

The next decision comes in the form of investment management.  Some folks are self-managers, meaning they enjoy the process of building their own investment portfolio.  Some individuals want no part of this process, and prefer professional assistance.  401(k) plans often have an “investment lineup” that consists of various mutual funds that can be selected from.  One potential downside is that your investment menu is much more limited than it would be in an IRA.  For some, however, this may be construed as a positive.  Less options = less to worry about.

If you’re an individual who values the concept of outsourcing to the expert, it likely makes sense to roll the funds into an IRA that is managed by an investment professional.  

The other key in the investment management discussion is ensuring that the route you choose allows you to take the appropriate amount of risk for your short and long-term needs.

3. Flexibility

All 401(k) plans are governed by their own set of “plan rules” meaning they’re all slightly different.  These plan rules are established by the employer that sponsors the plan.  In some cases, these plan rules can be quite inflexible.  It may be difficult to take distributions, and it can also be a hassle dealing with the record keeper that maintains the plan.  In other instances, however, the plan is fairly flexible.  In order to determine where your plan falls on this flexibility continuum, make sure to reach out to ask for assistance.

IRAs are much more flexible than 401(k) plans.  Although the taxation for the two accounts are very similar, these two types of accounts don’t share much in common.  IRAs, generally, are much more flexible than 401(k)s.

PRO TIP – These are only three of the factors to consider.  There are more factors to consider, including eligibility for participation at a new employer, the overall household balance sheet, cost, and others. 

As you can see, there are multiple things to consider before determining whether it makes sense to roll funds out of a previous 401(k).  If you need assistance weighing the pros and cons in your decision, be sure to let us know by visiting our Get Started page for more information!

Clark Hayden, CFP®*

Financial Advisor, Partner, CFP®