If you've lost your job, or are changing jobs, you may be wondering what to do withyour 401(k) plan account. It's important to understand your options.
What will I be entitled to?
If you leave your job (voluntarily or involuntarily), you'll be entitled to a distributionof your vested balance. Your vested balance always includes your own contributions(pre-tax, after-tax, and Roth) and typically any investment earnings on those amounts.It also includes employer contributions (and earnings) that have satisfied yourplan's vesting schedule.
In general, you must be 100% vested in your employer's contributions after 3 yearsof service ("cliff vesting"), or you must vest gradually, 20% per year until you'refully vested after 6 years ("graded vesting"). Plans can have faster vesting schedules,and some even have 100% immediate vesting. You'll also be 100% vested once you'vereached your plan's normal retirement age.
It's important for you to understand how your particular plan's vesting scheduleworks, because you'll forfeit any employer contributions that haven't vested bythe time you leave your job. Your summary plan description (SPD) will spell outhow the vesting schedule for your particular plan works. If you don't have one,ask your plan administrator for it. If you're on the cusp of vesting, it may makesense to wait a bit before leaving, if you have that luxury.
Don't spend it
While this pool of dollars may look attractive, don't spend it unless you absolutelyneed to. If you take a distribution you'll be taxed, at ordinary income tax rates,on the entire value of your account except for any after-tax or Roth401(k) contributionsyou've made. And, if you're not yet age 55, an additional 10% penalty may applyto the taxable portion of your payout. (Special rules may apply if you receive a lump-sum distribution and you were bornbefore 1936, or if the lump-sum includes employer stock.)
If your vested balance is more than $5,000, you can leave your money in your employer'splan at least until you reach the plan's normal retirement age (typically age 65). But your employer must also allow youto make a direct rollover to an IRA or to another employer's 401(k) plan. As thename suggests, in a direct rollover the money passes directly from your 401(k) planaccount to the IRA or other plan. This is preferable to a "60-day rollover," whereyou get the check and then roll the money over yourself, because your employer hasto withhold 20% of the taxable portion of a 60-day rollover. You can still rollover the entire amount of your distribution, but you'll need to come up with the20% that's been withheld until you recapture that amount when you file your incometax return.
Should I roll over to my new employer's 401(k) plan or to an IRA?
Assuming both options are available to you, there's no right or wrong answer to thisquestion. There are strong arguments to be made on both sides. You need to weighall of the factors, and make a decision based on your own needs and priorities. It's best to have a professional assist you with this, since the decision you makemay have significant consequen
ces — both now and in the future.
Reasons to consider rolling over to an IRA:
•You generally have more investment choices with an IRA than with an employer's 401(k)plan. You typically may freely move your money around to the various investmentsoffered by your IRA trustee, and you may divide up your balance among as many ofthose investments as you want. By contrast, employer-sponsored plans generally offer a limited menu of investments (usually mutual funds) from which to choose.
•You can freely allocate your IRA dollars among different IRA trustees/custodians.There's no limit on how many direct, trustee-to-trustee IRA transfers you can doin a year. This gives you flexibility to change trustees often if you are dissatisfiedwith investment performance or customer service. It can also allow you to have IRAaccounts with more than one institution for added diversification. With an employer'splan, you can't move the funds to a different trustee unless you leave your joband roll over the funds.
•An IRA may give you more flexibility with distributions. Your distribution optionsin a 401(k) plan depend on the terms of that particular plan, and your options maybe limited. However, with an IRA, the timing and amount of distributions is generallyat your discretion (until you reach age 72 and must start taking required minimumdistributions in the case of a traditional IRA).
•You can roll over (essentially "convert") your 401(k) plan distribution to a RothIRA. You'll generally have to pay taxes on the amount you roll over (minus any after-tax contributionsyou've made), but any qualified distributions from the Roth IRA in the future willbe tax free.
Reasons to consider rolling over to your new employer's 401(k) plan (or stay in your current plan):
•Many employer-sponsored plans have loan provisions. If you roll over your retirementfunds to a new employer's plan that permits loans, you may be able to borrow upto 50% of the amount you roll over if you need the money. You can't borrow froman IRA — you can only access the money in an IRA by taking a distribution, whichmay be subject to income tax and penalties. (You can give yourself a short-termloan from an IRA by taking a distribution, and then rolling the dollars back toan IRA within 60 days; however, this move is permitted only once in any 12-month time period.)
•Employer retirement plans generally provide greater creditor protection thanIRAs. Most 401(k) plans receive unlimited protectionfrom your creditors under federal law. Your creditors (with certain exceptions) cannot attach your plan funds to satisfyany of your debts and obligations, regardless of whether you've declared bankruptcy.In contrast, any amounts you roll over to a traditional or Roth IRA are generallyprotected under federal law only if you declare bankruptcy. Any creditor protectionyour IRA may receive in cases outside of bankruptcy will generally depend on thelaws of your particular state. If you are concerned about asset protection, be sureto seek the assistance of a qualified professional.
•You may be able to postpone required minimum distributions. For traditional IRAs, these distributionsmust begin by April 1 following the year you reach age 72.1 However, if you workpast that age and are still participating in your employer's 401(k) plan, you candelay your first distribution from that plan until April 1 following the year ofyour retirement. (You also must own no more than 5% of the company.)
•If your distribution includes Roth 401(k) contributions and earnings, you can rollthose amounts over to either a Roth IRA or your new employer's Roth 401(k) plan(if it accepts rollovers). If you roll the funds over to a Roth IRA, the Roth IRAholding period will determine when you can begin receiving tax-free qualified distributionsfrom the IRA. So if you're establishing a Roth IRA for the first time, your Roth401(k) dollars will be subject to a brand new five-year holding period. On the otherhand, if you roll the dollars over to your new employer's Roth 401 (k) plan, yourexisting five-year holding period will carry over to the new plan. This may enableyou to receive tax-free qualified distributions sooner.
When evaluating whether to initiate a rollover always be sure to (1) ask about possible surrender charges that may be imposed by your employer plan, or new surrender charges that your IRA may impose, (2) compare investment fees and expenses charged by your IRA (and investment funds) with those charged by your employer plan (if any), and (3) understand any accumulated rights or guarantees that you may be giving up by transferring funds out of your employer plan.
What about outstanding plan loans?
In general, if you have an outstanding plan loan, you'll need to pay it back, orthe outstanding balance will be taxed as if it had been distributed to you in cash.If you can't pay the loan back before you leave, you'll still have 60 days to rollover the amount that's been treated as a distribution to your IRA. Of course, you'llneed to come up with the dollars from other sources.
If you reach age 72 before July 1, 2021, you will need to take an RMD by December 31, 2021.
In some cases, you have no choice — you need to use the funds. If so, try to minimizethe tax impact. For example, if you have nontaxable after-tax contributions in youraccount, keep in mind that you can roll over just the taxable portion of your distributionand keep the nontaxable portion for yourself.
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