Avoiding 401(k) Mistakes When Leaving Employers
Retirement accounts such as 401(k)s can be valuable tools to put you in a better financial position in retirement. It is important not to commit mistakes with them though.
The biggest mistake people make with their 401(k) retirement accounts is not contributing as much as they could. It is not that these people have so much in these accounts that they don’t really have to put that much more in, as the typical retiree is left well short of what they should have if the goal isn’t to significantly reduce their standard of living when they get there.
We need to properly balance the present and the future, and this may come down to choosing cutting down on our spending in our working years, bringing this level down somewhat so that our levels of spending in retirement don’t drop off too much to cause hardship.
The lure of spending now is a strong one though and the majority of savers just don’t set aside enough money to retire comfortably on. They may even get discouraged and get themselves in a situation where there will be dread at the end of the road regardless, and they decide to just keep up with what they are doing now and deal with their retirement problems once they get there.
Dread is a relative thing though and if you dread the outcome of a good effort to save from here, if you don’t do it, you will have more to dread. As our income gets reduced, we can get to the point where even a minimally comfortable retirement period becomes out of reach, leaving us to suffer in squalor.
With a 401(k) though, when we don’t take proper advantage of our contributions, it’s not even that we aren’t saving enough, it’s also that we aren’t taking advantage of the benefits our employer is willing to provide us. This amounts to a lot of money left on the table in the end, and when your employer has their hand out wanting to give you money, that should serve as a much better incentive to contribute to your 401(k) than it currently does for most people.
When you leave your employer, either to find employment with a different one or to retire, your 401(k) will need attention. Your employer has been taking care of it all along, and often times you can just keep it with them, but if you want to do something else with it such as move it to your new employer’s plan or roll it over into a different type of retirement account such as a traditional IRA, a Roth 401(k), or a Roth IRA, or cash it out, you will need guidance, and you are on your own here pretty much.
No one from the IRS will be calling you to offer help, your former employer won’t be helping you get situated elsewhere, and your new employer may be willing to help you with their plan but aren’t really vested in whatever you have going on elsewhere, so you do need to be aware of what the options are and what the best one for you may be.
Given that we are responsible for the transition, a lot of people make mistakes and end up settling for less than they should have, including paying more tax than necessary if they had chosen a better option.
Confusion about 401(k) Plans Abounds
Many people just aren’t that aware of how this all works and what the options are. 42% of people have been found to be unaware that they could just leave their 401(k) right where it is now, and while that may or may not be the best option for them, we do need to be aware of what the options are to be in a position to decide which is best.
What we want to do is look at the current arrangements with our former employer to decide whether keeping it there, if we can, is better in this case then doing something else with it. 401(k) plans are not that standardized and you may have a deal where you are paying less fees with your old plan than if you move it to a new one, or the old one may offer investment options that are more suitable to you.
There are some people who will even just withdraw the funds from their old 401(k) out of ignorance, thinking that this is their only option. We need to target our withdrawals from retirement plans and especially don’t want to be paying the 10% withdrawal penalty that the IRS will slap on us if we do this before age 59 ½. This is in addition to the additional tax we will pay when we do this while we’re working versus waiting until we are retired and likely in a lower tax bracket.
28% of people aren’t even aware that cashing out with a retirement account involves either a penalty or taxes, which really hits home at how unguided a lot of people are. A third of people have actually done this, withdrawing early and paying the penalty and taxes, and this is certainly not a way to build your retirement nest egg when you are giving all this extra back to the IRS that you shouldn’t.
They will often actually spend the money, where they typically give up half of their savings to the government and then blow the other half on something else, perhaps seeing this as some sort of severance benefit that they now get to enjoy. This can destroy what little plans they had for their golden years.
Unless you truly need the money, for an emergency or spending that you just can’t say no to, cashing in retirement money early is always a bad idea and runs completely counter to the reason why you put the money in these accounts in the first place.
Deciding on the Best Option When You Leave
Aside from leaving the 401(k) money where it is, you can transfer it directly to your new 401(k), or if you are no longer seeking employment, you can roll it over into an IRA. As well, you can have your old 401(k) put into an IRA alongside your new 401(k) if you wish.
Deciding on which is better for you comes down to whether or not you want more flexibility with your investments, and IRA accounts are much less restrictive. 401(k) accounts are administered by your employer and have limited options, but these options may be just fine for you and you therefore should then just transfer this over to a new one.
However, 401(k) plans generally have lower fees, which are negotiated at the employer level, where IRA accounts are individual and you may pay a little more with them. It may very well be that these extra fees, if there are any, may be worth it to you if you want to do the choosing of where your money goes.
This is especially the case if your old 401(k) consisted of company stock and you just don’t want to hold their stock any longer, especially given that the employer no longer matches your contributions with their own. Employer matching can make this a sweet deal indeed but when that no longer is happening, it is time to re-assess the arrangement.
On the other hand, depending on what state you live in, IRA accounts may offer less creditor protection than 401(k) accounts do, and if you are in a situation where this may become an issue, this can be a reason to prefer a 401(k).
If you do transfer your money directly into a new 401(k), there isn’t anything to worry about as the transfer will occur without any risk, but if you do roll it over to something else, you are under a deadline. If you don’t know this, you can easily mess things up and have to pay tax on the amount and re-contribute it. This is something that needs to never happen.
If your employer sends you a check for your 401(k) funds, which would be the only option if you do not choose to keep your plan nor request a direct transfer, you have 60 days to contribute it to the rollover plan or it will be treated as a withdrawal, with full taxes and penalties. The IRS won’t take your excuses either, such as you forgot, and if you ever do this, the deal is done and you pay a big price for your lack of attention or understanding.
Just checking the transfer box is therefore the simplest solution, but it may not be the best. Whenever you leave an employer and have a 401(k) account with them, this is too important to be left up to ignorance, and with all the money that is on the line, we owe it to ourselves to fully check out what our options are and spend a little time thinking about what would be best for us.
Editor, MarketReview.com
Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.
Contact Robert: robert@marketreview.com
Topics of interest: News & updates from the Federal Deposit Insurance Corporation, Retirement, Insurance, Mortgage & more.