Your Retirement Plan and a Job Change: What You Need to Know
If I change jobs, what happens to my retirement plan?
At Scarborough Capital Management, we specialize in 401(k) management services, TSP analysis and pension analysis, so we get this question a lot.
Here’s the answer:
Preserve Your Retirement Plan (Don’t Spend It!)
Almost half of job-changers spend the money they have in an existing retirement plan when they change jobs.
Spending the money may be an understandable human response – you see a large amount of money coming to you, so you just start using it!
But in fact, that’s one of the worst things you can do for your retirement, for several reasons.
First, taxes and penalties will whittle down the amount significantly. The Internal Revenue Service (IRS) levies a 10 percent penalty on all retirement plan funds withdrawn before the age of 59-½, so 10 percent will come right off the top.
If your retirement funds are in a traditional account or a Roth account you’ve held less than five years, they will also be taxed at your applicable income tax rate on withdrawals.
Remember, appreciation on your retirement plan funds grow tax-deferred throughout your working life only as long as it’s in a tax-advantaged retirement fund. In many retirement accounts, any appreciation and compounding is subject to tax once it’s removed from these plans.
Although taxes and penalties are major reasons not to spend your retirement funds, they’re far from the only reason. There is also the loss of the potential growth opportunity in those accounts.
People may feel they have good reasons for spending the retirement funds. Some, after all, may take vacations between jobs and find the retirement money is available “just when they need it.” Others may face a few weeks without a paycheck before they are fully integrated into their new job’s human resources system. The retirement funds may seem like ideal money to tide them over.
A more strategic solution to both issues, though, is a comprehensive financial plan that lets you save for vacations and includes an emergency fund of several months’ salary.
So, what do you with your retirement account instead?
What to Do With Your Existing Plan
If you have a 401(k), pension or other retirement plan at your current or past employer, you should have a plan for it.
A lot of times, people will spend the money in their retirement plan when they change jobs because they’re simply not clear on what should (or can) be done with it. It can be complicated, so it’s wise to discuss your options with a financial advisor. Here’s a brief overview of your choices:
Some companies allow departing employees to leave the money in their plan. It’s important to check into your company’s policies to see if that’s an option.
If you choose this method, you will need to ensure that the company has your contact information until you retire. Without an address or e-mail, you could miss out on valuable information about the plan or your account.
Some companies allow new employees to roll over their existing 401(k)s or similar accounts into the new employer’s plan. A direct rollover means the money is transferred with no levying of taxes or penalties. It remains intact and continues to reap tax advantages. (401(k) management services can be complicated. For more on what this looks like, read our recent blog post: What Does Rolling Over a 401(k) Mean?)
You can also roll the money into an Individual Retirement Account (IRA). The rollover must be completed within 60 days of initiation. If you don’t, the money is subject to a 20 percent federal tax, in addition to the 10 percent penalty for early withdrawal.
Many companies will help you handle these rollovers. But you can also elect to receive a check yourself, and then open an IRA account with it.
Continue to Save and Review New Policies
Once you’re in your new position, don’t forget to participate in your new company’s retirement benefits, if available. Plans can vary by company. Don’t assume the policies and rules are the same organization to organization.
Matches for 401(k)s, for instance, may be different. One of the most prudent ways to save for retirement is to obtain any company match. If your new company’s match or allowable percentage contributions are higher than your old company’s, take advantage of it if at all possible.
It’s also prudent to raise the contribution amount if you received a raise in the new move.
Review your new investment options, vesting schedule, fees and more as soon as possible.
The information above applies primarily to defined contribution plans such as 401(k)s. But what if you have a union pension, or retirement benefits from the military?
In these cases, it’s important to understand your employer’s regulations and policies.
If you are eligible for a defined benefit plan, such as a pension, check to see whether you are vested.
In some cases, you may be given the choice between receiving the money now, in a lump sum, or receiving defined payments when you’re eligible to retire. There are many factors to consider when deciding which option makes sense for you.
Military retirement benefits can include both pensions and Thrift Savings Plans (TSPs). The latter share many characteristics with 401(k)s. (For more on TSPs, click here.)
Military service personnel should check thoroughly to determine their eligibility and features of their plan.
It’s a good idea for all job-changers to consult a financial advisor on their plans for existing funds, investing in new funds and their retirement itself. Mistakes can be costly.
If you’re looking for a financial advisor in Annapolis, MD, schedule a no-obligation consultation with the team at Scarborough Capital Management to see how we can help.