You’ve Changed Jobs or Retired…What To Do With Your Retirement Money

A scenario we encounter often at HFA:

A long time client comes into our office and tells us that she has just received a note from her employer that, due to separation of service, she will have to decide what to do with the $450,000 in her 401(k) plan. Another client gives us the news that he must decide what to do with the $250,000 in his 403(b) plan now that he has reached mandatory retirement age.  As a backdrop, Cerulli Associates, a well-known industry research firm located in Boston, released the following information: In 2012, about 3 million American workers rolled over some $289 billion from their employer-sponsored retirement plans into an IRA or into their new employer’s retirement plan. The bulk of that money—$204 billion, with an average account balance of $128,400—went into IRAs controlled by broker/dealers or investment advisers. That is about 70 percent of all of the rollover money. Next, about $84 billion, with an average account balance of $53,900, went into self-directed IRAs. And the balance of $1 billion, with an average account balance $91,000, was rolled into a new employer’s plan. Cerulli went on to say that by 2017, Americans will roll an estimated $451 billion into IRAs.

There are four basic choices that a participant has:

  1. Leave the money in the former employer’s plan (if permitted).
  2. Roll over the assets to the new employer’s plan (if there is a new employer and if rollovers are permitted).
  3. Roll over to an IRA.
  4. Cash out the account value.

It is important to note that only the first three options allow a participant to preserve the tax-deferred status of their plan savings. Once the choices are known, all of the various factors can be evaluated in an attempt to determine the best course of action for the client.

First of all, it must be determined if choice 1 is even possible. Unless the participant’s vested interest in the plan is large enough, the plan may not allow the funds to remain, or the plan may even call for a mandatory rollover into an IRA.

The same is true with choice 2. First of all, there must be a new employer and, even if there is, one of the problems is the difficulty involved in making the transfer. Some plans don’t allow it and, in other cases, whether it be a long rollover waiting period or a complex verification process, too many participants just don’t want the hassle and look for a simpler, although not necessarily the best, option. To their benefit, ERISA plans (a 401(k) for example) offer creditor protection under federal law, but IRAs are protected under state law, which can vary state to state. Also, participants in a 401(k) plan can borrow (in the form of a loan) up to 50 percent of their vested interest, or $50,000, whichever is smaller. No loans are permitted from an IRA.

Choices 1 and 2 are viewed basically the same. One major difference is that the client already knows the original plan and, if happy with the performance and service, it is hard to make a case for leaving it and moving the assets to an unfamiliar one. One point that could be made is the consolidation of assets. Many would prefer having all of the 401(k) assets in one location, rather than in the plans of several former employers. If analysis of the new employer’s plan shows lower fees and expenses and/or a wider selection of investment opportunities, that could also be a good reason to make the switch.

Of course, choice 3 is quite simple—almost all providers will hold their clients’ hand and do everything step by step with them. As evidenced in the Cerulli study, Choice 3 was the most popular choice based on the following:

  • Because many ERISA plans require distributions in either a lump sum or a fixed schedule, withdrawal flexibility is generally far greater with an IRA.
  • In general, there are more investment options available in an IRA.
  • For those who have had multiple employers and have not been able to transfer into each new employer’s plan, rolling over into an IRA puts all of your retirement assets into one place, making it much easier to keep track of and manage.
  • Fees could actually be lower in an IRA because there are no administrative fees.
  • There is no such thing as a “stretch” 401(k). A Stretch IRA is an estate planning concept that is applied to extend the financial life of an Individual Retirement Account (IRA) across multiple generations. A stretch IRA strategy allows the original beneficiary of an IRA to distribute assets to a designated second-generation beneficiary, or even a third- or fourth-generation (or more) beneficiary.
  • Control. If the assets are left in the former employer’s plan, the participant is less likely to keep up with ongoing changes to the plan
  • Penalty-free withdrawals are permitted in an IRA for first-time home buyers and certain education expenses.

Finally, although choice 4 may be best for some, for most under 59½, the taxation of the proceeds, plus the 10 percent tax penalty, is a factor that ranks at the top of the discussion. Choice 4 can be useful, even after paying taxes and penalties, if there is high-interest debt that can be paid off, or special expenses, such as medical treatment or education. In fact, if the participant is at least 55, it is possible to avoid the 10 percent penalty with the cash out option, but that is only true with an employer-sponsored plan, not an IRA.

As you can see, there are pros and cons to both. There is much evidence of participants making choices solely because they didn’t know what else to do. Our job is to educate in this respect and truly look out for the interests of the client.

Source: Chuck Lowenstein, Faculty, Kaplan University School of Professional and Continuing Education