According to the Bureau of Labor Statistics, the number of years that wage and salary workers stay with their current employer is 4.1 years. This data is from 2020. If you do the math that means on average, every worker has 5 different jobs during their lifetime. Unlike our parents or grandparents before us, employees no longer retire from the same company that they started working for. We’re now living in a time where it is not uncommon for someone to have 10 or more jobs during their lifetime.
If you are currently working for a company and plan on leaving at some point in the future, then it’s important that you know what will happen with your 401k account when you leave the company. Every time you change jobs, it’s important to think about what your next moves should be with your 401k account.
What is 401k Portability?
401k plans are typically portable. What this means is that most plans allow you (the participant) to roll your 401k into another retirement savings account (such as an IRA or your new employer’s 401k plan) without incurring an early withdrawal penalty. This means that if you leave your job and want to transfer your 401k from one provider to another, then you can do so without having to pay taxes or penalties on what is usually considered “cash out of pocket.”
If you leave a job for another company, the new company may have a provision in which you can “roll” your old 401k into the new company plan. The new plan may have restrictions on how you can invest your money since it will have its own plan investment options. In order to roll over your 401k into another account, the provider may charge a fee for this service. You will need to check with your new company’s Human Resource (HR) department for more details.
However, there may be better options for you regarding your old 401k. That option is to rollover your account into a self-directed IRA. A self-directed IRA is a retirement account that allows you to invest in the portfolio of your choosing. The only restriction is that you must use a custodian who will hold your assets.
What is a rollover IRA?
A rollover IRA is a traditional IRA or Roth IRA that you can use to move funds from your previous company into your own personal account. When you do this, the money will be transferred directly from your employer’s plan administrator to the custodian of your new account.
What are the different types of IRAs?
Traditional IRAs are tax-deferred accounts that allow you to put money away for retirement. You may be eligible for a tax deduction on your contributions if you qualify as a “traditional” or “regular” employee. The money grows tax free in the account until withdrawn at retirement, when all withdrawals will be taxed as income.
A Roth IRA is a retirement account that allows you to put money away for retirement. The contributions you make to a Roth IRA aren’t tax deductible (and they don’t show up on your annual tax return), but qualified distributions or distributions that are made up of previously taxed money aren’t subject to income taxes. To qualify as a Roth IRA, the account must be designated as one when it’s set up.
Cashing Out of Your 401k Could be Costly
When leaving your employer you may decide to “cash out” of your 401k. This could be a costly mistake since the employer will withhold 20% to prepay the tax you will owe. If you are under the age of 59½, you will also be subject to an additional 10% penalty.
This is why your best option is to rollover your 401k into an IRA account that allows for tax-free distributions.
Please note that your previous employer’s 401k plan might not allow you to keep money in the account once you have left the company.
Financial Advice and Guidance
Investors who go it alone and try to manage their own investment account often do this at their own peril. Because of the constant noise and bantering of Wall Street pundits and so-called experts, investors follow the noise only to be met with low returns and frustration.
You have probably heard us talk about the research firm DALBAR and how they study investor behavior relative to the performance of the market. In March 2022, DALBAR published a study (QAIB Study) regarding investor performance in 2021. Their findings: The QAIB study, which looks back to 1985, recently found that the average equity fund investor earned 10% less than the S&P 500, with a return of 18.39% versus the S&P 500’s 28.71%. This marked the third largest underperformance ever observed by the study. An individual investor’s underperformance is behaviorally driven and is lacking in a plan regarding their financial future.
Any investor who rolls over their monies should hire a fee-only financial planner and advisor who can create a prudent investment strategy. They can create a diversified, well-balanced portfolio that will meet your financial goals and align with a financial roadmap giving you the highest probability of investment success.
The bottom line is that if you don’t have a financial plan, then you won’t know where you are going and how long it will take to get there. You also won’t know how much money you need or what investments are best for your situation.
So there you have it: rolling out of your old 401k plan can be a great idea if you’re looking to diversify, lower investment costs, and get the input and advice from an investment professional.
Of course, investing isn’t about guessing when the market will go up or down; it’s about creating a diversified portfolio made up of various asset classes that follow the entire global market. It’s important to remember that an investment strategy only makes sense in the context of a detailed financial plan.