While not everyone has a 401(k) plan or similar workplace retirement plan, those who do should know what happens to their account when they leave a job and what the options are — and aren’t.
Your retirement savings plan offers you several choices for managing the money that has accumulated in your account when you decide to change jobs or retire. You will want to think carefully before making any decisions about withdrawing the money from your retirement plan, as some choices may entail greater tax liability than others. You have three main options for your 401(k).
Keep Your Money in the Plan
Perhaps the easiest thing you can do is leave your retirement savings in your former employer’s plan if permitted. However, you can no longer contribute to the plan. Keeping your savings in the plan is generally available to you if your account balance was more than $5,000 when you terminated employment. You can continue to enjoy tax-deferred compounding on investment earnings and receive periodic account statements and reports. While you cannot make new account contributions, you will have control over how your money is invested among the plan’s investment options.
If you are retiring, you may choose this option if your spouse is still working or if you have other sources of retirement income. However, minimum distributions must begin by April 1st of the following year you reach age 72. If you are starting your own business after leaving your current job, keeping your retirement money in your former employer’s plan may help protect your retirement assets from creditors if your new venture runs into unforeseen trouble.
Move Your Money to Another Retirement Account
You can move your money into another qualified retirement account, such as an IRA. With a direct rollover, the money goes directly from your former employer’s retirement plan to the new IRA plan. With this method, you never touch your money and continue to defer taxes on the full amount of your savings. If you are changing jobs, you can transfer your existing retirement savings into your new employer’s plan.
Take a Cash Distribution
You can have your money paid to you in one lump sum or installments of a fixed amount over a number of years, depending on your plan’s provisions. However, cashing out your retirement savings is generally cautioned by experts. Choosing to cash out all or a part of your savings when you retire or change jobs is considered a cash distribution. This means you are subject to ordinary income tax and a mandatory withholding of 20%. In addition, individuals under the age of 59 ½ (55 in some cases) could also be liable for an additional 10% federal tax withholding on early withdrawal, in addition to state taxes and penalties.
The 60-Day Rollover Period
Don’t panic if you choose to have your former employer make the cash distribution and are worried about the potential taxes and penalties you may face. You have 60 days to roll over the lump sum (including the 20% withholding tax) to your new employer’s plan. However, if you’re unhappy with your new employer’s retirement offers, you may choose to use a rollover IRA. This option allows you to have more control over your savings. In addition, both of these options will enable you to avoid the additional taxes or the 10% early withdrawal penalty.
Retirees Should Consider Potential Tax Consequences
If you are retiring and choose the cash distribution option for a lump sum payment, you will want to determine if any favorable tax consequences apply to your distribution. To qualify for a lump sum distribution, you must receive all of the money in your retirement plans with a company (including a 401(k), profit sharing, and stock purchase plans) within one year. In addition, there may be other distribution options available, so it is essential to contact your plan administrator for details about the options available under your plan.
Consult a Qualified Tax Professional
Talking to a tax professional before making any final decisions about what to do with your retirement savings can give you peace of mind. The tax professionals at Hayes & Associates can help you navigate your retirement savings options. Contact us today for a complimentary consultation.
