If the new year brought with it a change in your employment situation, it’s a good time to carefully review your options for your existing 401(k) plan. Here’s what you need to know to properly manage your 401(k).
How much you have saved makes a difference. If you have less than $5,000, your former employer may require you to cash it out or roll it over into a new plan. Then it’s up to you to ensure the money is reinvested into another 401(k) plan or an individual retirement account. But don’t dawdle. You have 60 days to do so, or prepare to pay a 10 percent penalty.
If you have $5,000 or more saved, another option is to keep your money right where it is — in your former employer’s plan. That’s especially true if the fees for managing your 401(k) are low, says Greg McBride, chief financial analyst at Bankrate.com. Look for expense ratios (a measure of what it costs to operate an investment) that are 0.5 percent or less for index funds; 1 percent or lower for actively managed funds; and 1.25 percent or less for actively managed international funds.
If you left your previous job on less-than-friendly terms, don’t let those emotions sway you when it comes to your retirement savings. “In any aspect of investing, letting emotions guide your actions is dangerous,” McBride says. If the plan has low fees and meets your investment goals, and you meet the minimum funding requirements, there’s no reason not to leave your money right where it is.
Don’t cash out. The biggest mistake people make when leaving a job is to cash out their 401(k), says Meghan Murphy, a director at Fidelity Investments. About 20 percent of workers cash out their plans within five years of leaving a job. That’s especially true among younger workers with $10,000 or less in savings. Many millennials see that amount as inconsequential in meeting their retirement goals.
“That can really set people back in saving for retirement,” Murphy says. That’s because of the power of compounding, the snowball effect that happens when your earnings generate even more earnings. Invested over decades, $10,000 could add several hundred dollars of monthly income in retirement.
Rollovers are your friend. The easiest way to keep saving for retirement and save yourself some hassle is to have your funds rolled over directly into an IRA without touching the funds, McBride says. Most large brokerages, such as Fidelity and Vanguard, can manage the transaction for you.
You can also do what’s called an indirect rollover. In this scenario, a check for your 401(k) savings comes to you, and then you have 60 days to reinvest it in an IRA or a new employer’s 401(k). Unlike with a direct rollover, however, your former employer is required to withhold 20 percent of your savings for income tax purposes. If you don’t reinvest the money within 60 days, the funds are taxed as ordinary income. You’ll also be on the hook for state income tax (if your state has one), and you’ll incur a 10 percent penalty if you’re under age 59½.
Easy access to cash. One other benefit of staying with your former employer’s plan is if it allows you to borrow from your savings. Unlike cashing out, loans taken out against your nest egg aren’t subject to a 10 percent penalty — unless you neglect to pay it back. Having quick, easy access to cash in an emergency is a valuable financial tool. But if you take out a loan while you’re still working for your current employer, beware that you may have to repay the money when you leave the company. Otherwise, the funds are treated like a taxable distribution.
Know your vesting rules. Murphy cautions those who are looking to leave employment voluntarily to be aware how much of their savings has been vested with the company. Some employers require workers to be employed a certain length of time before being fully vested. If you leave a job before that time, you could leave a big chunk of money on the table.
Keep track of your accounts. If you’ve changed jobs several times over the years, you may have several 401(k) plans. If that sounds like you, it pays to consolidate your accounts, either into an IRA or your new employer’s 401(k) plan. Having your savings in one place will likely reduce the amount of fees you’re paying to manage those funds. What’s more, having all your money in one spot helps you keep track of your savings — especially if you’re novice investor.
Murphy also advises savers to ask questions. There’s a lot of expert guidance available in the marketplace, she says, adding: “Understanding your options will really help you to make the right decision for you.”
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6 Facts to Know About Your 401(k) originally appeared on usnews.com
