Millennials and Gen Z are job-hoppers. Gone are the days of working decade upon decade at the same company, then retiring on a pension you worked so long to earn. It seems like everything just flipped on a dime, but the transition has been taking place since 1980 or so. Young folks today just can’t sit still! I guess it’s all about finding that perfect job you love to do.
It creates a challenge for your finances though. A rule of thumb in personal finance is that you should almost always contribute to your company’s 401(k) up to the match to get the employer’s contribution at no cost to you. It’s an instant 50% or 100% return on your money (depending on the company’s matching percentage). Here’s the catch – you often have to stick around with that firm for at least a few years to keep the matching funds. Many workers under 40 years old end up leaving for another job before the matching funds are ‘vested’.
So that’s one tricky part – it’s not always the greatest advice to contribute to the 401(k), believe it or not. Another issue departing employees face is what to do with the old 401(k)? It can be a pesky item since the account may not be a big sum of money. Obviously, if you are about to retire, and have worked at one company for a long time, then you might have a very large 401(k) – and the right strategy of what to do with it extremely important – sit down with us to develop the best plan!
Let’s focus on young people who may have a small 401(k). What should you do? There are several options.
- Roll it over to an IRA. Nowadays, this is quick & easy. It’s often free. What’s great about this choice is that you can open a Rollover IRA and simply move the account there. You also get experience with the mechanics of the investing world. So it might lead you to invest more for your future since you already have an IRA opened. With this option, you can have either a Rollover IRA or a Roth IRA depending on the nature of the money in your old 401(k).
- Leave it at your old employer. The problem here is the investment choices are often not the best and you might be paying fees. Also, some people even forget about the old account!
- Combine it with your new job’s 401(k). Here, you just transfer the account once everything is set up at your new job. There’s nothing wrong with this, so long as the investment choices in the new retirement plan are solid and the fees are low.
- Cash it out. This is the worst option quite often. When you cash-out a 401(k) before age 59 ½ you will pay income tax and a penalty on the withdrawal (assuming the contributions were pre-tax). If it’s just a $500 balance in your 401(k), ok, no big deal, but if it’s an account worth many thousands, then there will be a big tax bill come next spring!
At TFC, we recommend rolling over the old 401(k) to an IRA. We can help you do this – it’s a walk in the park for us. And it benefits you since you have access to a much bigger universe of investment choices and lower fees in most instances. We can tailor the Rollover IRA to you, and have it fit within your overall financial plan. When the time is right, we can even do a conversion to a Roth IRA so it can then grow tax-free forever.
Sometimes your old employer won’t let you keep the account with them. They will pro-actively cut you a check for the balance of the account and say ‘sayonara’. What do you do then? You must act! You have 60 days to invest that check into a Rollover IRA or into your new employer’s 401(k) to avoid it counting as the dreaded cash-out (option number 4).
For some individuals who own company stock, it may behoove you to leave the money in the old 401(k) due to the tax rules. This gets into the tax-weeds (we at TFC geek-out on this sort of thing), but if you own highly appreciated company stock, you get a tax break if you make the right moves. We can help you take advantage of what’s called the Net Unrealized Appreciation (NUA) rule. It’s tedious but can save you from a hefty tax bill. Just know that if you own your employer’s stock in your 401(k), talk to us first before deciding.
Here’s the point
- Most workers today are job-hoppers, so a common situation that arises once you leave a position is that you have a 401(k) left behind. You typically have 4 options – roll it over to an IRA, combine it with your new job’s 401(k), leave it in the old 401(k), or cash it out.
- Sometimes the former employer will force you out by sending you a check – you have 60 days to contribute the check to a Rollover IRA or deposit it into your new job’s 401(k).
- What we don’t want is for you to cash it out, and then be required to pay taxes and a possible penalty on the withdrawal.
Action items
- If your old 401(k) is a few thousand dollars or less, it’s probably no big deal. But you should make a move to consolidate the account, so you don’t forget about it.
- If you are in your 20s and 30s with an old 401(k) worth more than just a few thousand dollars, talk with us about the best strategy and (often more importantly) how it fits into your long-term financial plan.
- If you are about to retire, and the old 401(k) is a major part of your nest-egg, you should certainly sit down with us to formulate the right plan. The most optimal strategy can save you quite a bit of money.
Photo by Patrick Tomasso on Unsplash