With so many options, which one is the best one for you?
When you leave a job, figuring out what to do with your retirement accounts is a big decision. Whether it’s a 401(k), 403(b), or another type of plan, you’ve got a few options to consider. Each one has its pros and cons, so understanding them can help you make the best choice for your financial future.
Option 1: Roll It Over to an Individual Retirement Account (IRA)
Pros:
- Greater Control: Moving your retirement funds to an IRA gives you more control over how your money is invested. You can choose from a wide range of investment options, including stocks, bonds, mutual funds, and ETFs.
- Potentially Lower Fees: IRAs often have lower fees compared to employer-sponsored retirement plans. Lower fees mean more of your money stays invested and can grow over time.
- Avoid Losing Track: By consolidating your retirement accounts into an IRA, you reduce the risk of losing track of your old employer’s plan. This is especially useful if you’ve worked for multiple employers over your career.
Cons:
- Management Responsibility: With greater control comes greater responsibility. You will need to manage your investments personally or hire a financial advisor.
- Transfer Process: Rolling over to an IRA involves paperwork and coordination with both your old and new financial institutions, which can be time-consuming.
Tip:
- Research and compare different IRA providers to find one that offers the investment options and tools you need. Look for low-cost providers with good customer service.
- Remember, you want to avoid cashing out the balance. Instead, initiate a transfer to prevent triggering a taxable event. If you cash out this account you’ll owe income tax on the distribution, plus a 10% early withdrawal penalty if you’re under age 59½
Option 2: Roll It Over Into Your New Employer’s 401(k)/403(b) Plan
Pros:
- Consolidation: By rolling over your old plan into your new employer’s plan, you can consolidate your retirement accounts. This makes it easier to manage and track your retirement savings.
- Continued Tax-Deferred Growth: Your funds continue to grow tax-deferred, and you can make new contributions to the account.
Cons:
- Fee Structure: Employer-sponsored plans often have higher administrative fees compared to IRAs. Be sure to understand the fee structure of your new employer’s plan.
- Limited Investment Options: Employer plans typically offer a limited selection of investment options, which may not align with your investment strategy.
Tip:
- Confirm with your new employer’s HR department that rollovers are allowed and understand the steps involved in the process.
Option 3: Leave It with Your Former Employer
Pros:
- Simplicity: Leaving your account with your former employer is the easiest option, as it requires no action on your part.
- Immediate Access: You retain access to your funds and can continue to manage them through your former employer’s plan.
Cons:
- Limited Control: You will have limited control over the investment options and how the account is managed.
- Potentially Higher Fees: Employer plans can have higher fees, which can erode your retirement savings over time.
- No New Contributions: You cannot make any new contributions to the account, which can limit your ability to grow your retirement savings.
Tip:
Keep a record of all your retirement accounts and regularly update your contact information with each provider to avoid losing track of your funds.
Option 4: Convert to a Roth IRA (For Traditional 401(k)s)
Pros:
- Tax-Free Withdrawals: When you retire, withdrawals from a Roth IRA are tax-free, which can be a significant benefit if you expect to be in a higher tax bracket.
- No Required Minimum Distributions (RMDs): Unlike traditional retirement accounts, Roth IRAs do not require you to take minimum distributions at a certain age.
Cons:
- Immediate Tax Liability: Converting a traditional 401(k) to a Roth IRA means you will owe taxes on the converted amount. This can be a significant tax hit if you have a large balance.
- Complexity: The conversion process can be complex, and it’s crucial to understand the tax implications. Consulting with a financial advisor is recommended.
Tip:
- Plan the conversion during a year when your income is lower to minimize the tax impact. Consider spreading the conversion over several years.
- This can be advantageous for estate planning, as you can leave the account to heirs without forcing them to take distributions.
Option 5: Cash Out the Account
Cons:
- Immediate Tax Hit: Cashing out your retirement account triggers an immediate tax liability. The amount you withdraw will be added to your taxable income for the year, which can push you into a higher tax bracket and result in a substantial tax bill.
- Early Withdrawal Penalties: If you are under 59½, you will likely face a 10% early withdrawal penalty on top of the regular income tax. This can significantly reduce the amount you receive.
- Loss of Future Growth: By cashing out, you lose the opportunity for your retirement savings to continue growing tax-deferred. This can have a severe impact on your long-term retirement goals and financial security.
- Reduced Retirement Savings: Withdrawing funds from your retirement account means those funds are no longer available for your future. This can leave you with insufficient savings when you retire, potentially forcing you to work longer or reduce your standard of living.
Think about how each option fits with your long-term financial goals. Whether you value control, simplicity, or tax efficiency, pick the choice that best supports your retirement plan. Take the time to weigh the pros and cons so you can make a smart decision that helps you grow your retirement savings and reach your financial goals.
And if you’re not sure which option is best for your financial goals, don’t hesitate to reach out to your 3rd Decade Financial Mentor to chat about your options OR sign up for Financial Mentoring here.
