Life Events: Changing Jobs
In today’s competitive job market, the chances are strong you’ll change employers one or more times throughout your career. And with each job change, you may have a decision to make regarding your employer’s retirement plan.
One of the most important things that people don't pay attention to is their previous employer. In the excitement of a new job, most people forget about their old retirement account, HSA account and sometimes even their leftover vacation days. You may also have a flexible spending account or dependent care account with your previous employer. All these accounts need to be taken care of to get the best out of a job change. Here are some of the options and how to handle a job change.
 Your 401(K) account: This is probably the most important item when you change employer. You have following options when it comes to your old 401(k) accounts.
 Transfer the old retirement account for your benefit in to a Rollover IRA
You may be able to leave your retirement funds where they are and manage them
Rollover account to your new employer plan
Cash out your old retirement account
The first option lets you maintain the tax-deferred status of the retirement funds, while keeping the retirement funds under your direct control. You may expand your investment choices, and you’ll be able to make additional contributions to the IRA, within IRS guidelines. A Rollover IRA also lets you consolidate retirement funds into a single account. This may be particularly appealing if you have more than one retirement account held for your benefit with your former employer’s plans. Also, you may be able to convert your 401(k) account in to a traditional IRA and then to a Roth IRA if you qualify. You'll pay taxes up front but you get a Roth IRA account that will pay off in long terms. IF you decide to rollover your old retirement account in to an traditional or Roth IRA, you should do "Custodian to Custodian" transfer. This will save you hassles with taxes and IRS. One of the simplest way to do it is to open an IRA account with one of the online brokers(Scottrade, Ameritrade etc) and then contact your old retirement plan and let them know that you'll be transferring it to a new rollover IRA. You will have to provide them the name of the new custodian(for example, Ameritrade) and the account number of your new IRA account. You will have full control of your IRA account, You can invest in stocks or mutual funds. You can even leave it in money market funds. IF you need investment advice, you can contact them and they will help you out with your investment decision.
Second option is to leave your retirement funds with your old benefit manager and manage them. This option lets you maintain the tax-deferred status of the retirement funds. At the same time, though, the retirement funds remain under the umbrella of your former employer’s retirement plan. Your investment choices remain limited to those available through your former employer, and you cannot make additional contributions to the retirement plan. They may also charge you fees since you're not contributing anymore but you can get same investment choices and good returns. One of the important things to keep in mind is that unless your retirement account is over $5,000, most firms will send you an automatic distribution unless you make arrangements to transfer your account. Remember, even if they held taxes and sent you a check for your distribution, you still have 90 days to rollover these funds in to a new IRA account and get credit for your taxes and avoid the early distribution penalty but it will be lot more work.
Third option is to bring your old retirement funds in to your new employer retirement account. You may have to satisfy an eligibility period before you can fully participate in the plan. This is pretty much identical to "custodian to custodian" transfer but you get the benefit of your new employer retirement fund choices as well as single account to manage. However, you have to keep couple of things in mind before you pick this option. First of all if you're going to leave your new employer in next couple of years, you'll face same issues again with transferring retirement funds.
Last and the least favorable option is to cash out. This is also known as "Early Distribution". This option puts money in your pocket right away but at a big cost to your long term financial future. First of all you'll pay 10% early withdrawal penalty. Then you'll pay federal taxes, state income taxes, social security taxes and Medicare taxes. On top of everything, final distribution amount will be treated as ordinary income and will be added to your gross income at the end of the year for calculating federal and state income tax. You may also lose the potential value of future earnings. If distribution amount is substantial, it may even put you in a higher tax bracket causing you more financial pain. If you decide to take a cash distribution, keep in mind that you don't have to cash out the entire account balance. You can take a portion in cash and potentially avoid taxes and penalties by rolling the remainder into another qualified retirement plan. Here are some simple calculations to show you the full financial impact of an early distribution.
Assumptions:
Total funds in your old Retirement account = $25,000
Your Tax Filing Status = Married filling jointly. Current Federal Tax Bracket = 25%, State income tax = 7%
| Total Retirement Funds |
100% |
$25,000 |
| Early Withdrawal Penalty |
10% |
$2,500 |
| Social Security |
6.2% |
$1,550 |
| Medicare |
1.45% |
$362.50 |
| State Income Tax |
7.00% |
$1,750 |
| Federal Tax |
25% |
$6,250 |
| |
|
|
| Total Taxes |
49.65% |
$12,412.50 |
| Net Payout |
50.35% |
$12,587.50 |
It is very clear from the table that you paid almost 50% of your retirement funds in taxes. On top of everything, the net payout of $12,587 can also put you in a higher(for example, a 28% tax bracket) and that will add to your tax liabilities at the end of the year. Bottom line - Even though cash out puts money in your pocket, you lose big time in taxes and chances are that the money you received from cash out will be spent and not saved for retirement.
Your Other(HSA, FSA) accounts: These accounts offer same tax advantages as 401(k) or IRA accounts. Money deposited to these accounts in deducted at a pre-tax basis giving you almost 30-40% tax break. So when you change jobs, you should pay close attention to these accounts as well. If you were enrolled in HDHP plan with HSA, you can move your HSA account to any bank you would like. Money deposited in HSA is employee's money and you can take it with you. Only exception would be employer's contribution, if any. Employer's contribution may be subjected to some terms and conditions that you must meet in order to claim that money. If your new employer offers HDHP plan, you can rollover your old HSA funds to your new HSA account. If they don't, you can put it in any HSA stand alone account and continue to use it for healthcare related expenses. Flexible spending and Dependent care accounts are pre-tax dollars but you must use it by end of the year or lose it to federal government. Remember, you have until April 30th, to submit claims for the priory year qualified expense.
You should also contact human resources to cash out any unused vacation time that you may have had. Remember, most employers allow you to only accumulated up to a certain amount on PTO and sometimes PTO that is allowed to be paid out is even less than that. So before you leave your job, make sure you use any vacation that will not be paid out. |
