If you have recently left or lost your job, you have some financial decisions to make. There are immediate concerns to address; getting the right health insurance coverage in place and adjusting your budget for income changes are priorities. Once those issues are addressed, you need to decide what to do about your workplace retirement plan accounts. Most people have four options.
Cash it out
As simple as it sounds, you can ask that the plan administrator send a check made out to you for the balance in your plan. But there are significant downsides from which it may be difficult to recover. On tax-deferred accounts, taxes will be due. Your employer will withhold federal taxes and write the check for the balance. If you are younger than 59.5 years you will have to pay an additional 10% tax penalty for an early withdrawal. Finally, you will have restart building your retirement savings from scratch.
Leave the money in the old plan
Most plans will allow former employees to leave their retirement plan balances in the old plan. This helps the employer by keeping balances high and offers leverage to keep plan fees as low as possible. In 2019, Fidelity reported that 55% of workers in workplace retirement accounts administered by the company are choosing to leave their assets in a former employer’s 401k plan a year into retirement. In 2015, 45% chose the same. They did not report how many of these were intentional decisions compared to workers simply doing nothing.
Transfer it to a new employer plan
If your new employer plan allows, you can transfer the proceeds from a former employer plan. Your investments would continue to grow income tax deferred and you would avoid any tax penalty or income taxes. Downsides include being limited to the new plan investment lineup or finding out the new plan is more expensive than the old plan.
Direct rollover into an IRA
With an Individual Retirement Account (IRA) rollover, you can transfer qualified retirement plan balances directly into a traditional IRA. Both income and penalty taxes are avoided. There are several advantages to utilizing a rollover IRA. An IRA will allow you to continue pursuing tax-deferred or tax-free growth. An IRA can help consolidate balances that have accrued at more than one employer plan. And an IRA will offer greater investment choice of funds or allow you to better work with an investment advisor. There are some disadvantages too. If you retire in the year you turn 55, you can take penalty-free withdrawals from that employer’s 401k plan. With an IRA, you must wait until you are 59.5 to take penalty-free withdrawals. And the federal Employment Retirement Income Security Act (ERISA) shields employer sponsored retirement plans from creditors. This isn’t the case with an IRA.
There is no one ideal answer above, your specific circumstances will determine what is best for your situation. If you need help, find a trusted advisor who can guide you.