401(k)/403(b) Options After Leaving a Job or Retiring
Whether you're transitioning to a new opportunity or stepping into retirement, knowing your options for your employer’s retirement plan is crucial for making informed financial decisions. This applies to all employer retirement plans such as 401(k), 403(b), TSP, and 457. Let’s break down your choices and what they mean for your future.
Option 1: Leave It with Your Former Employer
One of the simplest options is to leave your 401(k) with your former employer. However, there are several potential drawbacks to consider. Employer-sponsored plans often offer limited investment options compared to IRAs, which can restrict your ability to optimize your portfolio. You might also have less control over your investments and encounter communication issues that make it harder to stay on top of your strategy. Lastly, you most likely will have to begin taking RMDs which can be difficult to keep track of when you have multiple retirement accounts. Here is a post I wrote all about RMDs if you’d like to read more about them.
Option 2: Roll It Over to an IRA
Rolling over your 401(k) to an Individual Retirement Account (IRA) is a popular choice because IRAs often offer a wider range of investment options compared to employer-sponsored plans. This option can make managing your retirement savings easier by consolidating them into one account. To roll over your 401(k), you’ll need to fill out your 401ks rollover paperwork or online form. Ideally, you’d opt for a direct rollover where the funds are transferred directly from your 401(k) to your new IRA. I say this because if you choose an indirect rollover (they mail you a check), you must deposit the funds into the new IRA within 60 days, or it will be considered a distribution and taxed accordingly.
Option 3: Roll It Over to a New Employer’s 401(k)
If you’re starting a new job, you might be able to roll your old 401(k) into your new employer’s plan.
Option 4: Cash Out
While cashing out your 401(k) is an option, it’s generally not recommended due to the tax implications and potential penalties. Withdrawals before age 59½ typically incur a 10% penalty on top of ordinary income tax which has a 20% mandatory withholding, significantly reducing your retirement savings.
Tax Considerations
When rolling over a 401(k) to an IRA, it’s crucial to follow the rules to avoid taxes and penalties. With a direct rollover, your funds move from one account to another without any tax withholding. If you choose an indirect rollover, you must deposit the funds into the new IRA within 60 days, or it will be considered a distribution and taxed accordingly. I make a point to repeat this because it’s probably the single biggest risk in the rollover process. You do not want to accidentally deposit that check at the bank. Some 401k providers will mail you the check directly and then you can deposit it, while others will save you a step and mail it directly to the advisor to deposit on your behalf. The best is for it to be transferred electronically and directly, but surprisingly, many providers won’t offer this option.
Reassessing Your Investment Choices
Leaving a job or retiring is a great time to reassess your financial plan. Consider factors like your risk tolerance, income needs/sources, and taxes. It might be wise to shift towards a more conservative allocation as you approach or enter retirement. I usually think of it as transitioning from the growth stage of life to the income and preservation stage.
Taking Income
When you remove money from your 401k or IRA, you will only be taxed on the amount you withdraw. Don’t be worried that rolling it over makes it a giant taxable event. Up until RMD age, the amount you distribute and spend is entirely up to you. After RMD age, there is a minimum, but no maximum.
Some people might look forward at their income needs and conclude that they have other more tax efficient places to take income from prior to their 401k or IRA. These situations merit a deeper look in order to see what strategies might be available to minimize taxes. More information on this topic is available here in this detailed post I wrote about Roth conversions.
Final Thoughts
Evaluating your 401(k) options after leaving a job or retiring is important to make the best decision for your financial future. Whether you leave your 401(k) with your former employer, roll it over to an IRA or a new employer’s plan, each option has its benefits and considerations.
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Individuals are encouraged to consult their tax and legal advisors (a) before establishing a Retirement Account, and (b) regarding any potential tax, ERISA and related consequences of any investments or other transactions made with respect to a Retirement Account. Tax laws are complex and subject to change. Steward Partners does not provide tax or legal advice.
Other factors to consider when making a rollover decision include (among other things) the differences in: (1) investment options, (2) fees and expenses, (3) services, (4) penalty-free withdrawals, (5) creditor protection in bankruptcy and from legal judgments, (6) required minimum distributions or “RMDs,” (7) the Tax Treatment of Employer Stock, and (8) the availability of plan loans (e.g., loans are not permitted from IRAs, and the availability from an employer’s qualified retirement plan will depend on the terms of the plan.)
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