FREE NEWSLETTER

Take It or Leave It

John Yeigh  |  July 22, 2019

THE CLASH, the U.K. punk-rock group, famously asked, “Should I stay or should I go?” Retirees and job changers need to tackle the same question when they leave their employer.

At that juncture, you have four options for your 401(k) or 403(b) account: You can leave the balance in your old employer’s plan, roll over the balance to a new employer’s plan, roll over the balance to an IRA or close out the account.

You can generally keep your retirement savings in your old employer’s plan, even if terminated, provided you have a balance of $5,000 or more. When you leave employment, you’ll likely have to pay back any outstanding loan balances and, if not fully vested, surrender some or all of the matching funds.

Will you lose part of the employer’s matching contribution? My advice: Carefully check the plan’s prospectus before assuming the entire account balance will be yours. The prospectuses for many large company plans are posted on the web, while most smaller companies outsource their plan’s administration. If in doubt about account balances or policy, check with your human resources department or plan administrator. There could be the chance for easy money: You may find that more of the employer’s match will vest if you simply delay your departure by a week or two.

You may want to leave your money with the old employer if the plan has low costs and broad investment choices. That might include institutionally priced funds that you couldn’t access on your own or a stable value fund offering higher-than-market interest rates. On the other hand, if the plan has high fees and mediocre investment options, run for the exits.

What about retirees? Again, it depends on the quality of the plan. Many retirees of my former employer stay with the company’s well-managed and low-cost plan for decades.

If your former employer’s plan is administered by a financial services company, often the financial company will be anxious to retain your account. Indeed, my wife has hung onto two old 401(k) accounts for 18 and 28 years. Both are administered by financial companies.

After she left those two jobs, both employers offered buyouts of their modest pension plans. My wife rolled the payouts into her 401(k) accounts, where the pension assets have been compounding ever since. The money feels safer invested with a financial services firm than as the pension obligations of smaller companies.

While employees can transfer 401(k) assets from an old employer to a new employer, this may not be a top choice, unless the new employer’s plan is exceptionally good. If you want to compare plans, BrightScope provides details and ratings for thousands of employer plans, and highlights those plans that provide better options.

The good news is, 401(k) and 403(b) accounts can be readily rolled over into an IRA at any financial firm. When my daughter was laid off because her employer exited one of its businesses, she simply transferred her 401(k) balance to an IRA with a low-fee financial services firm. She now has more control of her assets. She also has far more investment choices, including a full-range of target-date funds and access to low-cost index funds, plus added flexibility when rebalancing. In addition, she’s now diversified across institutions, because she has her rollover IRA, her 401(k) at her new employer and a Roth IRA invested elsewhere.

One wrinkle to keep in mind: If you want to take advantage of the so-called backdoor Roth by funding a nondeductible IRA and then converting it to a Roth, you’ll want to keep the 401(k) money at your old employer or roll it into your new employer’s plan. If you move the money into an IRA, it’ll cause those backdoor Roth conversions to trigger much larger tax bills. You can learn more about this in HumbleDollar’s money guide.

The final option is to close out the former employer’s account and take a distribution. This surrenders the tax deferral, creates an immediate tax obligation and, if you’re under age 59½, usually triggers a 10% tax penalty. Those are all bad outcomes—all of which you’ll want to avoid.

John Yeigh is an engineer with an MBA in finance. He retired in 2017 after 40 years in the oil industry, where he helped negotiate financial details for multi-billion-dollar international projects.  His previous articles include Got You CoveredNothing to Chance and Hers, His and Ours.

Do you enjoy HumbleDollar? Please support our work with a donation. Want to receive daily email alerts about new articles? Click here. How about getting our weekly newsletter? Sign up now.

Subscribe
Notify of
5 Comments
Inline Feedbacks
View all comments
parkslope
parkslope
1 year ago

Good advice. Another wrinkle is that some plans only offer retirees the choice between a lump sum distribution or an annuity. This is the case with one of my wife’s plans. Because of her former employer’s ability to negotiate group rate annuities, her annuity payout is somewhat higher that what she could purchase on her own. This make the decision between taking the payout and putting it into a personal IRA versus opting for the annuity difficult.

Tom Murin
Tom Murin
1 year ago

If you are 55 or older you won’t owe the 10 % excise tax if you take a distribution when leaving your job (for any reason – “Rule of 55”). I changed jobs earlier in the year and rolled my 401K, Roth 401K and a pension distribution to Vanguard where I already had my IRA. I had to establish a new Roth IRA account for the 401K Roth. I don’t believe in leaving anything with a prior employer. I could see a case for moving the 401K to the new employer (if they take it) – you’d have a larger balance and more $$ available if you wanted to take a out a 401K loan from the new plan. Be aware of your options and do what you feel is best for your situation.

postcarbon
postcarbon
1 year ago

Hi – terrific article – thank you. I am wondering if you can help me with a question in this area…I have a traditional IRA which contains ~30% after-tax contributions. I have kept track of the after-tax contributions by filing IRS form 8606. NOW, I want to roll this IRA into my employer’s excellent 401k plan so I can pursue the ‘back door roth’ IRA strategy. Does the form 8606 filed with IRS still keep track of my after-tax contributions once they are moved to a 401k? Financial advisor says “ask CPA”; CPA says “that is a question for you financial advisor” I say, TYPICAL!

David J. Kupstas
David J. Kupstas
1 year ago
Reply to  postcarbon

I work in the pension industry. I’ll try to make an effort to look into this Monday when I get to work, only because I am somewhat curious about the answer myself.

David J. Kupstas
David J. Kupstas
1 year ago
Reply to  postcarbon

I’ve looked into this tonight a little bit. I am quite confident that Form 8606 is not used to track after-tax contributions in the 401(k). That’s done by the recordkeeper or plan administrator. In addition, the Form 8606 instructions say not to report rollovers to qualified plans as distributions. Here’s my best guess of how it works. If your IRA is $70,000 pre-tax and $30,000 after-tax, and you roll the whole thing over to a 401(k), then you report the $30,000 as a distribution on Form 8606 but not the $70,000 pre-tax. All you are trying to do is whatever it takes to bring the Form 8606 to $0 so you don’t have to file it in a future year, and I believe this gets you there, although I have not tried it in a real situation. This advice plus $4.50 will get you a drink at Starbucks, but maybe it will lead you to the right answer. Naturally, the 401(k) administrator is going to ask you what portion of the rollover is pre-tax or after-tax (or you need to volunteer that information or else you will get taxed again on the after-tax contributions when they come out). An alternative theory is that you can’t roll over the after-tax money. You have to have it paid to you. I didn’t find that that was the case. You may want to talk to your 401(k) people about whether you can actually roll after-tax contributions into their plan.

Free Newsletter

SHARE