Starting the New Year in a New Job? What To Do With Your 401(k)
After the year we had in 2020, a lot people started 2021 in a new job. The pandemic-related shutdowns and the fires that ravished California devastated many businesses and industries worldwide. As Sonoma County residents, we and our neighbors know this all too well.
The good news is that many of the people who found themselves without a job are now working again. This is great to see, but changing jobs can be a stressful and confusing time.
At Montgomery Taylor Wealth Management, we have clients who are navigating this transition. Many of these people had worked for their previous companies for years and never considered leaving. Now, they wonder what the change will do to their retirement plans.
With many other people in this same situation, the Sonoma County wealth advisors at Montgomery Taylor Wealth Management have put together some helpful information. If your specific question isn’t answered below, let us know. Schedule a complimentary, no-obligation conversation with our team of financial advisors. We’re here to help.
Let’s talk! The Sonoma County wealth advisors at Montgomery Taylor Wealth Management are here to help.
What Happens to Your 401(k) When You Change Jobs?
Most people have a general idea of how their 401(k) works, but we’re asked a lot, what happens to it when you change jobs?
The more appropriate question is, what do you want to see happen with it?
You actually have choices when it comes to your 401(k), and depending on your personal finances and retirement goals, some of those choices may be better than others. Some options will give you more control over your money than others.
To find out which is right for you, first decide what you plan to do with that money. Then, discuss your options with a financial advisor. The choice you are about to make can directly affect your level of retirement income. It’s seemingly small decisions like this one that can have long-lasting effects if not thought out wisely. Make your decision count!
Option 1: Arrange a 401(k) Rollover and Transfer the Money Into an IRA
Rolling over your assets can be a good strategy if you want control over the money that has accumulated in your 401(k) account. An IRA is a retirement account you own, as opposed to one your employer owns. It permits a wide variety of investment options. An IRA also gives those assets the chance for additional years of tax-advantaged growth. If you roll over your 401(k) money into a Traditional IRA, you won’t have to take Required Minimum Distributions (RMDs) from the IRA until after you turn 72.
Talk to your financial advisor about a trustee-to-trustee transfer. In this scenario, you don’t touch the money during the transfer – and that’s very important. If you do, it becomes a taxable event.
Option 2: Leave the Money in the Plan
Some employers will allow you to leave your money in the 401(k) when you leave, and in some cases, letting the money sit for a bit longer may not be a bad idea. Your 401(k) features tax-deferred growth, so if you already have a great deal of retirement assets in addition to your 401(k), you could withdraw retirement income from your taxable accounts as your retirement starts and let your workplace retirement plan money grow and compound for a while longer.
The main disadvantage here is you don’t own your 401(k) plan; your employer does. So your plan might leave you with a narrow range of investment choices, and if too many of them tend to underperform, you may want more options. If you can direct those assets into an account you own, your options may broaden greatly.
Option 3: Cash Out
Cashing out your 401(k) may sound like the easiest option (and one that will give you money now while you’re transitioning into a new role), but it might be the worst choice you could make.
When you take a lump sum distribution from your 401(k) plan, you will be taxed. And it can be a pretty price! The IRS categorizes a 401(k) distribution as regular income, so your income taxes for the year in which you cash out may be staggering. Additionally, when you withdraw the money, it is no longer invested, therefore losing the chance to grow and compound further, as it could in an IRA or another tax-advantaged investment account.
Should You Roll Over Your 401(k) Yourself?
A DIY 401(k) rollover can turn into a nightmare! This isn’t always the case, but many people unintentionally sabotage their retirement savings by attempting to do it on their own without paying enough attention to the rules. (Read our recent blog post: Why Pay for an Advisor When You Can Find Free Advice Online?)
For example, when 401(k) assets are rolled over into an IRA, a trustee-to-trustee transfer is often the easiest, most hassle-free way to move the money, and the transfer should have no tax consequences.
In a trustee-to-trustee transfer, you never touch the money. At Montgomery Taylor Wealth Management, our Sonoma County wealth advisors will contact the administrator of your 401(k) plan on your behalf and request that the 401(k) funds be transferred into an IRA by check. After the request is made, the 401(k) plan administrator will write a check in the amount of the 401(k) balance, payable to the new financial firm hosting the IRA that will house those funds. Our Sonoma County wealth advisors will oversee the transfer of assets and follow through to see that any necessary paperwork is processed appropriately. Through this manner, the money from a 401(k) can be directly transferred into an IRA without tax consequences. The IRS will send you a Form 1099-R with a distribution code of “G” in box 7, indicating that this was a direct transfer and not a taxable event.
What Is Right For You?
If you’re not sure what option is right for your situation, talk with the financial advisors at Montgomery Taylor Wealth Management. We have years of experience helping busy families plan for retirement, be it in good times or in bad. This also gives you the chance to discuss your new job, your new income and any new benefits that you are eligible for at your new company. If you’re a current client, we can update your financial plan and adjust where necessary. If you’re not a current client, we can establish a financial plan based on your new situation. Either way, schedule a no-obligation conversation and get the discussion started. A little professional advice can go a long way.