The pandemic was, without a doubt, one of the most disruptive events to the labor market in more than a decade. Over the past year, millions of Americans were furloughed, lost their jobs or left their jobs for new opportunities amid a shift to work-from-home and a historic number of job postings.
If you were among the millions who landed in a new job over the past year, you may have some financial housekeeping that could benefit your retirement picture over the long run, particularly if you contributed to a 401(k) plan with your former employer.
A 401(k) is a retirement savings plan that’s sponsored by your employer and allows you to make contributions before income taxes are taken out of each paycheck (contributions to a Roth 401(k) are made post-income tax). A little bit of every check from your old job went into that account, and your old employer may have even kicked in an additional match to boot. Depending on how long you worked there, you may have amassed a sizable amount of savings.
But getting that sizeable amount of savings moved from your former employer isn’t as simple as asking them to cut a check due to the favorable tax treatment of 401(k)s. Don’t worry, it’s pretty easy, but you’ll want to make sure you do it correctly to avoid triggering unnecessary, and costly, withholding taxes, penalties or fees on the transaction. Here’s how to roll over a 401(k) from an old employer.
Choose your destination
First, you’ll want to consider where you want to put your old 401(k) funds. You have several options. Each choice offers advantages and disadvantages depending on your unique financial needs and retirement plans. It’s important to carefully consider each option looking at factors such as eligibility, investment options, fees, expenses, and services.
Take it to the new job. If your new employer accepts rollovers (not all plans do) and you like the choice of investments, you can take your funds to the new plan. If you are a “hands-off” kind of investor, this might be a good option. Within an employer’s 401(k) plan, you are limited to a selection of investments that were likely vetted for quality by financial pros or your company’s 401(k)-investment committee.
Open your own retirement account. If you’re a little more “hands-on”, or you don’t like what’s offered in your new employer’s plan, you can roll that 401(k) into an IRA or Roth IRA. With this option, you’ll have a plethora of investment options to put your money into. Investment options can include but are not limited to individual stocks, mutual funds or a variable annuity (which has multiple fund options). And, given the range of options, you might find funds that have similar objectives with lower fees than what was offered in your 401(k) plan.
If you take a 401(k) and roll it into a Roth IRA as opposed to a traditional IRA, the amount you roll over will be included in your taxable income. However, any gains in a Roth IRA will be generally tax-free when you withdraw them years down the road in retirement. If you want to completely avoid incurring taxes prior to retirement, roll your 401(k) into a traditional IRA. Similarly, if you are rolling over a Roth 401(k) into a Roth IRA, you don’t need to worry about a tax hit. If you want to avoid paying taxes, make sure you are moving money into the same kind of account (e.g., 401(k) to traditional IRA and Roth 401(k) to Roth IRA).*
Roll into a variable annuity: Rather than an IRA, you could roll over all or a portion of your 401(k) into a variable annuity. Variable annuities are a hybrid of investments and insurance. You get a combination of tax-deferred growth potential, but they also set you up to take advantage of guaranteed income an annuity can provide. They’re variable because the return they provide as you’re accumulating funds for retirement can go up and down depending on the performance of investment options — called subaccounts — that you select.
When you reach retirement, you can withdraw your funds all at once, over time, or convert them into an income plan that provides reliable income for the rest of your life (keep in mind there may be fees or penalties for early withdrawals). Guaranteed income streams in retirement can help reduce your exposure to market volatility, and help you manage longevity risk (outliving your savings). Speak with your advisor if this option appeals to you, and keep in mind there may be fees and expenses involved with the process.
Go the direct route
Regardless of your chosen destination, this next step is critical.
After you’ve chosen where you want the money to go, contact your old 401(k) provider and request a direct rollover. These two words are very important, because with a direct rollover your old 401(k) provider will write a check to your new plan provider not to you personally. Your old provider will write a check addressed to “ACME (your company) 401(k) PLAN FBO (for the benefit of) YOUR NAME.” While you might receive a check, you won’t be able to cash it at a bank. You’ll need to hand it over to your current 401(k) or IRA provider to add to your account.
When you request a direct rollover, the entire balance will be transferred to your new account without any taxes or fees. This is opposed to an indirect rollover, in which a check is made out to you, and in your name. In this latter case, your old company will assume you are cashing out the 401(k) account and will need to withhold 20 percent of the funds for federal tax purposes (the whole balance will be available to you). You’ll then have 60 days to invest the rest of that money into your new account or pay additional taxes and fees. Regardless, that amount withheld by your old employer will need to be reported on your tax return, which might push you into a higher tax bracket as a result. To avoid paying taxes, you can deposit an amount equal to the withholding in your new account, if you have the funds available. You would then get that withheld amount back when you file a tax return.
It goes without saying, if you’re trying to simply move your 401(k), a direct rollover is the easiest way to avoid any tax headaches.
Leave it. You can also leave your money in your old employer’s plan. If you are satisfied with the investments and don’t mind checking in on the account from time to time, this can be an easy, no-effort option. There are a few drawbacks, however.
When you leave your 401(k) behind, you won’t be able to contribute to the account anymore because you no longer work there. You’ll be limited to holding only the funds offered in that plan, however. What’s more, if you’ve changed jobs a few times during your career, you might have multiple 401(k) accounts floating around, and that can make managing your money difficult or lead you to forget about an account entirely.
Cash it out. Finally, you could cash out your old 401(k) and use the funds how you see fit. However, this option can cost you significantly. You’ll immediately pay income taxes on that lump sum along with an additional 10 percent penalty if you are younger than 59-1/2 (unless some other exception applies). Some accounts even charge a one-time closing fee if you go this route. But that’s just the hit you’ll take today. Over the long-run, a decade or more, you’ll miss out on years of potential tax-deferred growth that could go a long way in retirement.
*This publication is not intended as legal or tax advice. Taxpayers should seek advice based on their particular circumstances from an independent tax advisor.
Guarantees in an annuity are backed solely by the claims-paying ability of the issuer. The underlying investment options are subject to market risk, including loss of principal, and are not guaranteed. No investment strategy can guarantee a profit or protect against a loss. Variable contracts have limitations. You should carefully consider the investment objectives, risks, expenses and charges of the investment company before you invest. Refer to the Prospectus for details of all fees and charges.