By: Phil Kernen
If you have recently left or lost your job, you need to make some financial decisions. There are immediate concerns; getting the right health insurance coverage and adjusting your budget for income changes are priorities. Once you address those issues, you must 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 to restart building your retirement savings from scratch.
Leave the money in the old plan
Most plans will allow former employees to leave their retirement funds in the old plan if they exceed a minimum account size. Doing so helps the employer keep balances high and offers leverage to keep plan fees as low as possible. Downsides exist. We may work for many employers over our career, and leaving retirement funds in each plan can become burdensome to track and increase the risks of forgotten accounts. A 2021 study estimated that 24.3 million forgotten 401k accounts are holding $1.35 trillion in assets, with another 2.8 million accounts left behind annually. Some of these will eventually be claimed, but the opportunity costs could be material.
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 for early withdrawal. 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
Finally, you can transfer qualified retirement plan balances directly into a traditional Individual Retirement Account, avoiding income and penalty taxes. An IRA rollover offers several advantages. An IRA will allow you to continue pursuing tax-deferred or tax-free growth. An IRA can help consolidate balances accrued at more than one employer plan, eliminating the risk of forgotten accounts. And an IRA will offer a broader investment choice of funds or allow you to better work with an investment advisor.
There are some disadvantages too. If you retire the year you turn 55, many employer 401k plans let you take penalty-free withdrawals. With an IRA, you must wait until age 59.5 for penalty-free withdrawals. An IRA does not offer any loan options like a 401k.
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 and explain your options.