American workers will have more than 11 jobs in their lifetimes, according to the Bureau of Labor Statistics. Chances are many of your employers will offer a retirement plan, such as a 401(k), 403(b), or a Thrift Savings Plan if you work for the federal government.
But knowing what to do with an old retirement plan when you change jobs can be confusing. Here are 6 costly mistakes to avoid.
1. Forgetting about an old retirement account
Once you move on to a new company, don’t forget about the retirement account you left with your previous employer. You have several options to manage it wisely. However, depending on your account balance, your old employer may take some action.
If your account has less than a minimum amount, typically $1,000, your old company has the option to cash you out. If you have more, but less than $5,000, your employer can transfer your balance to an IRA on your behalf.
When your retirement account satisfies a minimum balance, you can leave it in a previous employer’s plan, but there are downsides. One is you can’t make any new contributions to the account after you’re no longer employed. Another is you may be charged extra maintenance fees or be prohibited from benefits employees get, such as taking hardship distributions.
However, if you do leave a retirement account with a previous employer, you have the same access and ability to manage it as you did when you were employed.
2. Cashing out an old retirement account
While it might be tempting to cash out an old retirement account, that’s a big mistake you should avoid. Problem is, cashing out is incredibly expensive. In general, if you’re younger than age 59½, distributions are subject to income tax, plus an additional 10% early withdrawal penalty. Depending on your income and tax rate, cashing out a traditional 401(k) with $50,000 could leave you with only $25,000 after paying taxes and the penalty.
In addition, you lose all future growth your account could have earned. For instance, if you’re 30 years away from retirement, $50,000 could grow to more than $500,000, assuming an 8% annual return.
3. Not getting the benefits of account consolidation
Having your money in multiple accounts usually makes it more difficult to track and manage. Instead, consider the benefits of having all your retirement money with a single financial institution means. You’ll have a larger account balance, which may qualify you for lower fees or other perks.
If you land a new job that offers a retirement account, you may be able to roll over your old plan into the new one. You can also roll over an old retirement account into a new or existing Individual Retirement Account. Doing an IRA rollover gives you the most flexibility and control of your retirement money. You choose the financial institution and have the freedom to pick from a wide range of investments. As long as you complete a rollover within 60 days after requesting it, you won’t have to pay income tax or a penalty.
4. Missing legal protections
The Employee Retirement Income Security Act of 1974 doesn’t allow creditors, except the federal government, to touch funds in a qualified workplace plan. For example, if you got into financial trouble because you couldn’t pay your mortgage, the lender could sue you, but wouldn’t be able to take your 401(k) money to repay the debt.
The major downside of rolling over a retirement plan with a previous employer into an IRA is the funds may not be protected from creditors, depending on the laws in your state. Be sure to ask your existing or potential new IRA custodian about your state’s regulations.
5. Not factoring in your age
If you lose or quit your job in the year you turn 55 or later, you can take withdrawals from a retirement plan at work without having to pay the hefty additional 10% early withdrawal penalty. But if you do a rollover into an IRA, you must wait until age 59½ to avoid the penalty.
If you think you may need to access retirement funds between the age of 55 to 59½, consider leaving your money in the old account.
6. Doing an indirect rollover
There are two methods to roll over an old workplace retirement account to an IRA or a new employer’s plan:
- With an indirect rollover, you receive a check for your retirement funds made payable to you. Problem is, a mandatory 20% withholding penalty will be applied, even if you intend to complete a rollover.
- With a direct rollover, your old plan administrator simply transfers your funds directly into your new account and no taxes are withheld. This is an easy and seamless process that benefits you the most.
In some cases, your old retirement plan may mail you a check made payable to the new account custodian or trustee. This is still considered a direct rollover because the funds are not made payable to you.
What’s right for one person’s old retirement account may not be a wise decision for another. Evaluate your options carefully and always seek advice from your retirement plan custodian or a financial professional when you need retirement advice.