A 401(k) plan is an employer-sponsored retirement plan that will allow you to invest for retirement with pre-tax income. What happens to your 401(k) if you decide to change employers or retire? Well, that decision is ultimately made by you. You could leave the money in the old 401(k) plan, roll it over into an IRA, take it with you to a new plan, or cash out the account. Let’s take a look at these options just in case you ever find yourself in this situation.
Leave the money in the plan. The first option that you may want to look into is leaving the money in the current plan. If you plan to leave the workforce before age 59 1/2, this actually could be a strong option as most 401(k) plans will allow you to make penalty-free withdrawals if you separate from your employer at age 55 or later, while the age for IRA’s is 59 1/2
Two additional things to make note of are the fee structure of your current plan, and the opportunities for diversification. If the cost and fees associated with your current plan are low, staying with what you have is definitely worth considering. If the plan isn’t very well diversified, it could be worth it to move your money elsewhere.
Switch to your new employer’s plan. Sometimes the plan you’re on just isn’t a great option or you may just like having everything all in one single place for some reason. In those instances, what you want to do is verify whether or not your new employer offers what you’re looking for. Check to see whether your new job offers an equal or better plan based on low fees and diversification. Sometimes it’s a tough decision, and sometimes it’s just a no-brainer.
Also, for those with a lot of debt, it’s worth noting that 401(k) plans are usually protected from creditors under a federal law called ERISA (Employee Retirement Income Security Act of 1974). We’ll deal with that more in the next section.
Roll over to an IRA. If you will not need protection from potential creditors because you are debt free, or access to your money before the date necessary to avoid penalty, rolling your 401(k) over into an IRA is a rock-solid option.
IRA’s are also a bonus if you’re the type of person that likes to have everything in one place. If you have participated in multiple plans throughout your career, you can roll them all over into an IRA.
One thing to be aware of when considering rolling your 401(k) over to an IRA is the fact that, sometimes, employer-sponsored plans have better creditor protections than IRAs. What this means is, outside of the IRS, former spouses, and a few other exceptions, your 401(k) is generally safer from creditors than it would be in an IRA.
These laws are state-specific when it comes to non-bankruptcy situations. For instance, in my home state of Texas, the protection for IRAs is generally the same as it is for a 401(k). You will want to discuss these risks with a financial advisor.
Cash out. The last option is to cash out. The beauty of having retirement accounts is that the money in them works to generate more money for you in the future. Removing your investments too early will not only trigger a large tax bill, but it keeps your money from working for you.
There is also a 10 percent early withdrawal penalty for those cashing out before 59 ½ on top of the tax bill in some instances. It’s very rare that this is the best option for people that are not yet retiring, however, that is a decision you will ultimately have to make based on your financial situation.
It’s always worth the time and effort to pay attention to the investments we choose, however, if you think you may change companies in the future, it’s imperative that you take some time to learn about your options. Make sure you understand how diversified you are currently, and what cost and fees are associated with your current plan. Retirement accounts are always seen by employers as part of your compensation package, so it’s in your best interest to be aware of your options.
For an in-depth analysis of your personal situation, you can book a session with a financial coach below.
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