This question has come up quite often during the past few months due to the Covid-19 pandemic. With many companies forced to shut down or even worse go out of business, many folks have been left scrambling. There are some short-term and long-term consequences when considering what one should do with a former employer’s 401k. Let’s look into this further.
Remember, a 401K is a retirement vehicle
The first issue to address is understanding that your 401k, as robust or minor as it might be, is a retirement account. You have been setting aside these funds for however long of a time period for the propose of fueling your retirement. These funds are not to be considered “excess” at the time of separation from your current employer. Too many individuals, whether knowingly or unknowingly, take these funds and spend them unwisely. These funds should be considered as a last line source of income. Spending this money now, unless absolutely necessary, will have a negative impact on when and how much money you will have at retirement.
Should I take a distribution?
The IRS was allowing you to take a complete distribution of the funds from a former employer without having to pay the early distribution penalty of 10% prior to age 59 1/2. This was temporary stipulation allowed by the passing of the CARES Act in March 2020. (This is no longer available in 2021) The act also allows you to keep whatever portion you decide up to 100% of your withdraw. However, understand whatever portion you decide to keep, you will have to pay income tax on that amount. The CARES Act has an additional provision to address the taxation of the funds you decide to keep. You can distribute the total amount over your next 3 years of income tax returns. Again, if you absolutely need these funds to stay afloat, then use it for that purpose. Otherwise, rollover the complete amount into personal retirement account.
What about a Rollover?
If you have no current pressing need for the funds, then rollover of the funds into a personal account is highly recommended. The main reason for this recommendation is access and control. As long as the funds sit in a former employer’s 401k plan administrator, your control and accessibility are limited. Many employer’s change 401k plan administration companies every so often. No longer being employed, this information might not get to you in a timely fashion. You are then left having to track your money down via the telephone and that can be a long and frustrating process. The more significant reason for rolling the funds over into a personal retirement account is control. First, due to the fact that you are no longer employed, you lose the ability to continue to fund the account. The money will just it there, invested however you had chosen or not while you were employed. This is a huge deal if this is your only source of retirement funding. You want to take advantage of the ability to continue to fund your retirement. Second, you have many different types of investment options moving the funds into a personal account. All employer plans are limited. Taking control of your money is once again now, highly recommended.
A sub-point to this conversation is the question of “Why not just rollover the funds into my next employers 401K?” This is legitimate question, however, it has it faults. I will present some of the concerns. One, what if you don’t get rehired for 6 months and your new employers has a 60 day, 90 day or 180 day waiting period for participation in their employer sponsored 401K plan?. Two, what if the new employers doesn’t allow roll in’s into their plan? Three, what happens if you have to change jobs two or three times within a short period of time? Four, what if your new employers plan is very restrictive in the types of investment options? As you can, this options brings more questions than answers.
Opening your own personal retirement account in the form of a traditional IRA and selecting whatever type of investments you so desire should be your best method of operation. In this way, should you change jobs frequently, or there is a waiting period for participation, etc… You have your personal account, which you control to funnel any and all 401k’s providing you piece of mind.
Looking for personalized options without fear of a commitment? Contact me directly at louis@louisromero.com and will happy to review you current situation and provide you with several options. Conversation is free!