What Should You Do With Your Old Employer Retirement Account When Changing Jobs?
Posted by Frank Napolitano on July 26, 2018
With the economy picking up, more people are changing jobs. This article will focus on just one of the implications of moving to a new job: what should you do with your old employer retirement plan? You have three options, each of which I will address in turn, highlighting the factors that we use to advise clients on how to choose the best one for them.
What is a rollover exactly?
Before we can talk about your options, we need to define some terms. A rollover is simply the transfer of funds from a retirement account, such as a 401(k), 403(b) or 457(b) plan, to an IRA or to another retirement plan. When done correctly, it is a nontaxable event that allows your savings to continue to grow tax-deferred until withdrawal. The IRS has a useful Rollover Chart, which summarizes how and when specific plans can be rolled over.
There are two very different types of rollovers. A direct rollover, aka a trustee-to-trustee rollover, transfers assets directly from an old plan to a new plan or IRA. Because of its simplicity, this is by far the preferred option. By contrast, an indirect rollover, aka a 60-day rollover, requires you to deposit your money into a new account with a check from your previous plan. If you don’t make the deposit within 60 days, the entire amount will be included in your taxable income and you lose the opportunity for tax-deferred growth on those funds forever. As if that’s not stressful enough, the IRS’s new (2015) one-rollover-per-year rule generally limits people from making more than one rollover from the same IRA within 365 days. The rule is complex. You can easily avoid having to figure it out by taking the direct rollover route.
Whether to roll over an old employer account is a complex question with lots of factors to consider. Let’s review the three options.
Option 1: Leave your money where it is
When a new client comes to Sensible Financial, we often see a surplus of financial accounts on their balance sheet. Sometimes these accounts are checking and savings accounts, but more often they are old employer retirement accounts. These accounts are often forgotten and can be very difficult to track down. This is especially true if you’ve had multiple jobs over the years.
Most of the time these accounts should be rolled over into either an IRA or your new employer’s retirement plan (assuming the plan allows it).
The primary reasons we see for making a rollover, rather than leaving the plan at an old employer, are:
- Investment options: employer plans generally have a limited list of investment options. With an IRA, you potentially have access to thousands of different investments.
- Fees and expenses: 401(k) plans and other employer plans have costs which are passed onto the plan participants. Sometimes these fees are obvious, such as administrative fees that appear on your statement, sometimes they are not, such as high expense ratios for mutual funds. Holding investments in an IRA tends to be more efficient.
- Simplicity: if you have multiple old employer plans it’s very difficult to track your retirement portfolio. Adding together all the various statements is time-consuming and probably unnecessary. Most people are better off with a simple, easy-to-understand balance sheet and that means fewer accounts.
That said, there are a few cases where staying put may make sense:
- Your plan may have investment options that are superior to those you could find elsewhere. This is rare, but we’ve seen certain plans, particularly government retirement plans, that may have investments options that are not publicly available. (The Thrift Savings Plan, which is part of the Federal Employees Retirement System, is a good example).
- You may decide that rolling your plan into your new employer’s plan is the best option (see below), but you may not become eligible to participate for several months. In this case, temporarily leaving your plan where it is would let you consolidate later.
- If you really need the cash and you are at least 55, you could potentially withdraw the money penalty-free even if you’ve not reached the age of 59 1/2. (Ordinarily, withdrawals from retirement accounts prior to age 59 1/2 would mean a 10% penalty, but under the unusually specific IRS code 72(t)(2)(A)(v) you might qualify for an exception).
Option 2: Roll your plan into your new employer’s plan
Each employer plan is different, but many plans accept rollover contributions from prior employers. For example, if you have a 401(k) at your old job, you may be able to roll over that plan into your new 401(k). The plan administrator for your old plan would sell all the funds, mail the check to your new employer’s plan, and the balance would appear in your new account.
This approach has several potential benefits. Having your monies at your new employer makes it easier to keep track of your investments over time. If your new employer has better investment options and/or lower fees you will have a more efficient portfolio. There are other plan features to consider as well. For example, your plan may allow you to take a loan, which, if needed, is much easier to do when you have a positive balance(!). Finally, if you are making “backdoor” Roth IRA contributions, a savings strategy that lets you indirectly make Roth IRA contributions under certain circumstances, it’s in your best interest to keep your pretax employer accounts separate from any IRAs.
Option 3: Roll your plan into an IRA
If you cannot or choose not to move your old plan to your new employer, you can also roll over your account into an IRA. An IRA, or Individual Retirement Account, is a tax-advantaged retirement account that you open at an investment firm or bank.
Like an employer retirement plan, an IRA offers tax-advantaged savings. Investment earnings as well as contributions grow (hopefully) in the account, tax-deferred, until you withdraw them in retirement. IRAs typically have a larger investment selection than employer retirement plans. IRAs may also offer you easier access to your funds, albeit with a 10% penalty prior to age 59 1/2, if needed.
Rolling your plan into an IRA has some potential drawbacks. The “backdoor” Roth IRA strategy may no longer make sense (see above). Secondly, certain employer plan features you may have had access to, such as a plan loan, are not available in an IRA. Finally, there is the difference in creditor protection between ERISA-covered accounts and IRAs. Although the details of ERISA creditor protection are beyond the scope of this article, suffice it to say that the protection from claims of creditors is superior for ERISA-covered accounts than IRAs. However, monies rolled over from an ERISA plan into an IRA retain their protections. Because of the additional protections involved and the need to distinguish these contributions from individual contributions, we recommend rolling over an old employer plan into a dedicated IRA (some custodians refer to these IRAs as “Rollover IRAs”).
You have several options when dealing with your old employer retirement accounts. Deciding whether to stay put or roll into another employer plan or IRA requires careful weighing of the pros and cons of each approach.
Frank Napolitano is a Senior Financial Advisor and CERTIFIED FINANCIAL PLANNERTM. To speak with Frank or another member of our team about your financial future, get in touch today.