Considerations When Exiting Your Employer
After a layoff, many people will have to deal with complicated financial decisions and it’s important to understand the impact of these decisions. One of the biggest questions we get asked as financial planners is “what should I do with my old 401(k)?”
Since the employee’s relationship with the employer has ended, the employee has several options on how to proceed with the benefits they accrued. Many times, the first reaction is to cash out the benefits to pay for current expenses and replace income. This can be a costly decision due to fees and can lead to a large tax bill. An employee’s 401(k) plan will be taxed as current income with an extra 10% IRS penalty if it is distributed to the employee before they reach age 59 ½. The good news is employees have several options to continue enjoying tax deferred growth on their assets.
The most common options are: (1) Roll the funds into an Individual Retirement Account (IRA); (2) Leave the funds in the ex-employer’s retirement savings plan, if permitted; and (3) roll the funds into their new employer’s retirement savings plan, if available.
1. Rolling funds into an IRA
Rolling a 401(k) into an IRA allows employees to continue enjoying the benefits of their retirement savings plan, while taking full control of their investments. An IRA is a personal account that the employee will have full control over. To move the funds into an IRA, a rollover request needs to be made with your plan administrator who then releases the funds through a check to your new IRA account.
Since your funds are no longer in an employer-sponsored plan, you will be responsible for monitoring and picking your investments going forward. Individuals may also rely on their financial planner to assist with this process.
2. Leave funds in existing plan
Depending on the plan, employees may be able to leave their funds in their old employer’s retirement savings plan if the plan allows for it. This must be considered on a case-by-case basis and even if the previous employer does allow previous employees to remain in the plan, it is important to review all options.
3. Roll funds into new Qualified Retirement Plan
Employees also may be able to roll their funds into their new employer’s sponsored retirement plan if they land at a new company. This is generally dependent upon the retirement plan options available to the employee at their new company.
Tax Considerations for Cashing Out Your Qualified Retirement Plan
For 401(k) plans and other qualified retirement savings plans, the IRS agrees to allow certain tax advantages to employees who save funds for their own long-term benefit. The IRS allows these funds to go into a retirement savings plan pre-tax and grow tax free until they are distributed. In addition to a current tax liability and 10% early-distribution penalty before age 59 ½, an employee also gives up the advantage of tax deferred growth if they take a distribution of their retirement assets early.
Next Steps
A layoff or separation of service from an employer may be the perfect time to sit down with a financial planner to see what options you might have going forward. It is important to understand the long-term impact of emotional financial decisions that we make today.
About the Author
Matthew Lenhardt is a Financial Planner with Insignia Financial Company. He focuses on assisting members of the automotive industry with their retirement savings decisions and helps to guide them to a successful financial future for them and their family. He is currently accepting new clients. To schedule a consultation, call 734-464-0935 or email mlenhardt@insigniafinco.com.
Securities and investment advisory services offered through Royal Alliance Associates, Inc. (RAA), member FINRA/SIPC. RAA is separately owned and other entities and/or marketing names, products or services referenced here are independent of RAA. RAA does not provide tax or legal advice. 17199 N. Laurel Park Drive, Suite 300, Livonia, MI 48152. 734-464-0935. 17905207-20191212
