What should I do with my 401K or Retirement Investments between jobs?
You have several choices:
1. Leave the money in your previous employer’s plan if the amount is over $5000.
2. Roll your funds from your previous employer plan into an IRA, Individual 401K,
SEP, or other retirement plan.
3. Withdraw money as cash (may be considered taxable income).
For more detail on each of these, see below:
1. If you choose to leave your money with your previous employer, you can still direct your investment choices according to the plan, however you will not be able to add money to the plan. Also, with most plans, you will not be able to withdraw money unless you take a full distribution from your plan. This is the primary disadvantage of leaving money in a prior employer’s plan. You may be able to transfer the monies directly to a new employer plan when you are re-employed (check with your new employer to see if they allow this type of rollover). The other disadvantage is that you are restricted with investments based on what the previous employer offers for investment choices. If you like many investment choices, you should choose option #2.
2. If you already have, or open your own IRA, Individual 401K, or SEP plan, you may transfer the funds (as a direct rollover) directly into your account. Why do many people choose to rollover their money to a new IRA, 401K, or SEP plan?
a) They want to have more investment choices available or perhaps they would like to have self-directed account, where they could invest in both traditional and some less traditional investments.
b) They may want the flexibility of taking a loan against their account, which is a feature available with an individual 401K. In that case, they can take up to $50,000 or half the account value, whichever is less. Taking a loan in your own account defers having to pay any tax or possible penalty. You make loan payments back to yourself with your own money into your own plan. No interest is paid to any outside lender; the interest is paid back to you. You do have to make these payments. You do not want to default on these loans because then all money loaned becomes taxable income.
c) Others choose to transfer to an IRA or SEP and have the flexibility of taking a partial distribution from their account. Partial distributions are allowed for a short-term need (60 days). You are required to return the money within 60 days. If you go beyond the 60 days, the IRS will rule that all the money be considered taxable income.
3. Cash withdrawal is the least favorable option because the entire amount that you withdraw is included as taxable income in the calendar year that you take the distribution. In addition, if you are less than 59 ½ years old you will pay a 10% penalty. There are some exceptions to the penalty such as disability, death and other hardships (for more about this consult the IRS web site or your accountant or other resource). For many people, your penalty plus tax could amount to almost half of what you take out of the plan, and you will be responsible for that tax by April 15 following the year in which you took the withdrawal. For most people, a loan would be a better advantage for them than this option.
NOTE: There is another option for avoiding the penalty tax called Regulation 72T, which allows you to take income payments based on a life expectancy formula. Consult a tax advisor or the IRS regarding the specific rules regarding 72T income distributions. Also, be aware that you can have as many IRA accounts as you need to. If you’re going to take some income based on regulation 72T, you may want to establish a special IRA account with just part of your money in that account.
Scott Simpson is a CERTIFIED FINANCIAL PLANNER™ and has been helping people create retirement, family legacy, investment, and insurance programs for 25 years.
(952) 225-0345 ~ firstname.lastname@example.org ~ www.focusfinancial.com
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