New Employer? Things to Consider Regarding the Old Retirement Plan.
When it comes to jobs, Americans tend to like change.
As of January 2022, the median number of years workers have been with their employer is 4.1[1].
The Secure Act 2.0 will soon require most new 401(k) and 403(b) plans to automatically enroll employees. Which means, more than ever, workers will have to decide what to do with those retirement plan assets after leaving their employer.
Which option is best? There are typically four choices:
Leave the money in the old employer’s retirement plan
Roll the assets to the new employer’s retirement plan
Roll the assets into an IRA
Cash it in
This table outlines some of the key decision points for each option, namely taxes, investment options, and fees.
Cashing in a 401(k) early could create a lot of taxable ordinary income and penalties for those below the retirement age. And once that option has been chosen, there isn’t much anyone can do to help.
So, let’s look at the other three choices a little closer.
Taxes
401(k) plans are typically funded via employee deferrals and employer matching contributions. In many cases, the contributions can either be pre-tax or after-tax.
Regardless, tax treatment shouldn’t impact the decision of leaving assets in the old plan, rolling them to the new plan, or rolling to an IRAs. When done properly, all assets will transfer to the new plan or custodian without triggering a tax liability.
Investments
Investment options vary by plan. 401(k) plan fiduciaries will typically make sure basic options like diversified stock funds, bond funds, and stable-value funds are available. A series of target-date funds should also be on the menu. These funds can be good options for hands-off investors, as they automatically invest more conservatively over time, as the participant’s retirement age draws nearer.
IRAs may offer the investor a much larger set of investment options. For investors who prefer choice or want to tailor the portfolio to their specific needs, the IRA could be more attractive.
Fees
Employer-sponsored retirement plan fees vary by plan. Again, plan fiduciaries are responsible for monitoring fees paid by the plan, and ensure the investment fees are reasonable. Many mutual funds have special share classes for retirement plans, and these retirement share classes are regularly among the cheapest options. Collective Investment Trusts (CITs) have become much more popular in recent years and are only available within these plans. CIT fees are often extremely low as well.
Do you prefer the 401(k) but want help managing the account? Ask your advisor if they can help with this. If the answer is yes, the fee could be similar to how they charge to manage IRA assets, too.
Fees for those who roll the plan assets to an IRA could be all over the board.
Do-it-yourselfers could pay close to 0% to manage their own portfolios. Index ETFs and mutual funds are extremely inexpensive, and stock trading costs have been reduced to $0 in most places.
Those who value professional advice should be able to choose from several fee models. Four of the more common options are commission-based advisors who earn a commission for each product sale, fee-based advisors who primarily charge a percentage of assets managed, fee-only advisors who eschew commissions completely in favor of fees-for-advice, or hourly planning fees. We are biased, preferring a fee-for-advice relationship with clients because we believe it most closely aligns our interests with our clients, but not everyone is a good fit for our model. I would encourage investors to interview several advisors. Find someone you trust who charges in a way that is transparent, simple, and reasonable for the services being offered.
Other concerns
The decision to keep your retirement plan with your prior employer or roll it will often come down to control and cost. But sometimes there is more.
Did you leave your old employer on good terms? Was it your choice, or theirs? Seeing a retirement plan statement with the name of the previous employer may conjure up some bad emotions. In these cases, investors rarely want to leave the plan behind. The new employer’s plan or an IRA could make more sense.
Do you make too much money to contribute to a Roth IRA, but contribute via a “backdoor” Roth IRA? Think twice before rolling those retirement plan assets into an IRA. It could impact how much of those Roth conversions are taxable.
What about early withdrawals? Generally, we encourage investors to leave assets in these plans long enough to avoid early withdrawal penalties, which is additional 10% tax. But sometimes life happens, and you need to access these dollars. Exceptions exist that avoid the early withdrawal penalty tax. And while they are similar for qualified plans like 401(k) accounts and IRAs, a few differences exist. SECURE Act 2.0, which we highlighted earlier this year, introduced a few new exceptions as well.
Summary
Deciding what to do with retirement plan assets after leaving an employer is not a slam dunk. Each option has pros and cons. 401(k)’s will often include low-fee funds but may have limited investment options. IRAs allow for customization but may impact other planning strategies. Cashing it in could mean buying that killer boat before lake season! Just make sure you don’t have to sell it next April to pay those taxes.
Interested in talking more? Email me at eric@divviwealth.com or set up time with the Divvi team to continue the conversations.
[1] https://www.bls.gov/news.release/tenure.nr0.htm
