What Happens to My Retirement When I Change Jobs?
By Kristi Vaughan
If you have recently changed jobs, or are thinking about doing so, one of the big decisions you'll be making concerns your retirement savings. What happens to the money you have accumulated in a 401(k) plan? What is a 401 (k)?
Company sponsored 401(k) plans offer employees an opportunity to save for retirement through tax deferred accounts. Employees have a choice of investment options and employers often match a portion of this savings.
As with Individual Retirement Accounts, withdrawals taken before age 59 are taxed as ordinary income and subject to a 10 percent penalty for early withdrawal. While these tax consequences are of little issue to you if you continue working for the same employer until retirement, they can be of major concern if you are changing jobs or have been terminated.
Available options
Although rules can vary depending on the specific plan, under federal tax law you generally have four options for 401(k) funds when you leave a company:
- Leave the money where it is (if you have more than $5,000 vested)
- Transfer the funds to your new employer's 401(k)
- Transfer the funds to a traditional IRA
- Cash out and pay the penalties
With any of the first three options you retain the tax-deferred advantage of the 401(k) savings.
Dangers of cashing out
A study by Hewitt Associates, a global HR outsourcing and consulting firm, found that nearly half, or about 42 percent, of employees who took 401(k) distributions in 2002 cashed out of their plans. But as tempting as this action might be, financial planners warn there are negative consequences beyond the initial penalties and taxes. Hewitt Associates, for example, points out that a $5,000 balance can grow to more than $50,000 in 30 years if invested at 8 percent. That same $5,000, however, would give you only $2,850 if cashed out and you paid 33% in state and federal taxes plus the early withdrawal penalty.
Cashing out of the plan can also negatively affect your ability to meet your long-term retirement goals since the money is no longer working for you on a tax-deferred basis.
Rollover IRAs
If you decide to open a rollover IRA you can do so at most mutual fund companies, banks or brokerage firms. Because the IRS invokes penalties and tax consequences if there are more than 60 days between withdrawing from one IRA and opening another, set up the new IRAS before transferring funds. The easiest - and safest way - to do this is to talk with representatives of the company where you are moving the IRA. They will have the appropriate paperwork to ensure that the money is never in your hands and is not subject to penalties.
