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Wealth Management - March 2019

by Stacy Wise | Mar 28, 2019

What to do with your 401k plan when you leave your employer

What To Do With Your 401(k) Plan When You Leave Your Employer

By Rick Imhoff, CFP ®

You can quickly build a sizable sum of money if you are fortunate to work for an employer who provides a retirement plan, like a 401(k), especially if your employer makes matching contributions.  Of course, at some point at the end of your employment with that company, for whatever reason, you will be faced with the decision of what to do with all that money you have accumulated.  Here are a few options to consider when making that important decision.

Take a Lump Sum

Unless you have a very small balance, this option is typically not a good idea.  If you have made pre-tax contributions, and the employer made matching contributions, the entire amount would be taxable in the year withdrawn and could put you into a higher income tax bracket resulting in even further erosion of your account balance.  In addition, anyone taking a lump sum distribution under age 59 ½ would be subject to a 10% tax penalty.  

Leave it in the Plan

The easiest option is to do nothing.  The funds can remain in the plan and continue to be invested as you have elected.  You can continue to make changes to your investment allocation and can even request periodic or regularly scheduled distributions.

However, if your vested account balance is less than $1,000, the plan sponsor can opt to distribute those funds to you if you don’t make an election otherwise.  If your vested account balance is between $1,000 and $5,000, the plan sponsor can opt to establish an IRA for you and rollover your entire balance.  If your vested account balance is over $5,000, then you can leave it in the plan.  So, if your account balance is less than $5,000 and you don’t like the what the plan sponsor might do with your account balance, you should notify the plan sponsor with your directions.      

IRA Rollover

In many instances, the option chosen by plan participants is to rollover their entire account balance into a Traditional IRA.  To do so, you first need to establish a Traditional IRA with a bank, brokerage firm, investment manager, financial advisor, insurance company, etc. and complete the forms provided by your employer, so the plan sponsor knows where to send your money.  For income tax purposes, it is best to have your funds sent from the plan directly to your Traditional IRA, or a check mailed to you payable to the custodian or trustee of your new Traditional IRA.

The benefit of rolling over your retirement plan balance to a Traditional IRA is that typically you have significantly more investment options to choose from.  Distributions from a Traditional IRA is sometimes easier to request and faster to process than distributions from a retirement plan.    

Roth 401(k)

The three options above focus on pre-tax contributions.  However, since the late 90’s, 401(k) plans could be amended to allow post-tax contributions to be designated as Roth 401(k) contributions, which would be segregated from the traditional pre-tax 401(k) contributions.  Plan participants select this option to have tax-free growth and tax-free distributions.  If you made contributions to the Roth 401(k) option, you have the same three options as stated above.  The primary differences would be that distributions would be tax free and rollovers would be made to a Roth IRA instead of a Traditional IRA.

It is important to know that if you chose to make Roth 401(k) contributions and received employer matching contributions, those matching contributions were made on a pre-tax basis and therefore would be taxable to you.  With that in mind, the three options above would apply.

As with any important financial decision, it is always a good idea to seek out professional advice to help you consider all options for your unique situation so you can make an informed decision.

 
 
 

Rick Imhoff, CFP®, is Executive Vice President & Senior Trust Officer for MidAmerica National Bank. He can be reached at 309-647-5000, ext. 1130 or by email.

Investments are not FDIC-insured, hold no bank guarantee, may lose value, are not a deposit, and are not insured by any federal government agency.

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