Now more than ever, many Americans are faced with the decision of what to do with their 401(k) or 403(b). Whether it is because of the Coronavirus – driven recession or simply a job change, understanding your retirement account options and weighing the advantages and disadvantages of each will help you in the long run. After all, the decisions we make today often have a lasting impact on our future. We’ve compiled a list of key options available to those who have suffered a job loss or perhaps decided to change employers.
Leave it where it is
Leaving your 401(k) or 403(b) with your previous employer is an option but typically only for those who have $5,000 or more in the account. If you have less than $1,000, your previous employer may cash you out, in which case you will have 60 days to roll the money into another account. If your balance is between $1,000 and $5,000, they can move your money into an IRA of their choosing. You can move it if you don’t like their choice. Keep in mind that if you do opt to leave your account where it is, your contributions will stop as well as any company match made by your previous employer. However, your money will still have the ability to grow if it is invested.
One drawback to this option worth considering is the limitation on investment offerings. You must choose from the limited pool of investments within the plan, unlike an IRA where the investment options are more plentiful.
Roll it into an IRA
Perhaps you haven’t secured a new job yet or maybe you would like more investment options to choose from or perhaps the fees in your new plan are high. If this is the case, rolling it into an IRA may be a good choice. IRAs yield strong tax benefits as they offer tax-free growth on earnings, and if you are eligible, the nonrefundable tax credits. You can contribute up to $6,000 per year or your taxable compensation (whichever is less) to the IRA or $7,000 if you are age 50 or older. Contributions may be tax-deductible for the year the contribution is made but that depends upon your modified adjusted gross income (MAGI) and the access you and/or your spouse have to an employer plan.
Also keep in mind that starting at age 72, required minimum distributions are mandatory and these are taxable (except for those distributions that consist of nondeductible contributions). If you choose to roll your old plan into an IRA, be sure you deposit it within 60 days, otherwise it will be considered a withdrawal and you will be taxed and penalized accordingly.
Roll it over to a ROTH IRA
ROTH IRAs are like traditional IRAs in some ways, but they differ in how your money is taxed. With ROTHs you will pay taxes when you make the initial contributions, but your withdrawals are tax-free. You’ll need to ensure you have enough money to pay taxes on the money you’ve converted into a ROTH when tax time rolls around (the higher the balance transferred, the higher the taxes). ROTHs also offer estate planning advantages and no RMDs.
A drawback to the ROTH is the tax hit you will incur to compensate for the taxes you’ve already deferred if you are moving a traditional 401(k) into the ROTH IRA. However, if you have a ROTH 401(k), you can roll over your money to a ROTH IRA without generating extra taxes.
Roll it into your new 401(k) or 403(b)
If you are starting a new job and your employer offers a 401(k) or 403(b), this is an option for you. Consolidating your plans from different jobs helps streamline your retirement savings, making tracking and management easier. Some employers offer professional advice as part of the new retirement plan too. This option is a tax friendly choice too as you won’t incur any new taxes, provided you transfer to the same account type.
Speak to your human resources department to ensure your new plan accepts rollovers. Also ask whether they offer matching and try to take advantage of this free money. Review the investment options and the fees carefully.
Withdrawing from your retirement account
For those who have lost a job and are struggling to make ends meet, it may be tempting to withdrawal from your retirement account. Think twice before doing so. You will be hurting your financial plan in the long run and will lose the gains that compounding gives you and your nest egg. It is also important to note that taking money out of the market when it is at a low will lock in your losses. If you stay invested, you can recover any losses and possibly make gains.
Typically, taking money from a 401(k) yields penalties and taxes, but the Coronavirus Aid, Relief and Economic Security Act (CARES Act) helps reduce some of these costs. The Act allows up to $100,000 from 401(k) plans and retirement accounts without paying a 10% penalty if the distribution meets certain criteria. It also allows you to spread out the tax impact of the withdrawal over the next three years. The distribution won’t be tagged as taxable income if you pay the bulk of the money within the three years. Always check with your employer regarding the CARES Act prior to making any withdrawals, as employers are not required to adopt the CARES Act.
For many Americans, unemployment is becoming a scary reality because of the Coronavirus. Before tapping your retirement accounts, consider using money from a savings account, look into obtaining a personal loan, file for unemployment, request help from the government and contact your creditors for relief. Take steps to take control over your financial situation.
Sources: Fidelity.com/ Bankrate.com/ Motley Fool/ Money.U.S.News/ CNBC
© Geier Asset Management, Inc. July 2020. Gregory Palacorolla, CFP ® is Director of Wealth Management for Geier Asset Management, Inc., a Registered Investment Advisor. The articles & opinions expressed in this material were gathered from a variety of sources, but are reviewed by Geier Asset Management, Inc. prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of July 2020 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual circumstances. In all cases, please contact your investment professional before making any investment choices. Geier Asset Management, Inc. is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.