When you terminate employment, you need to make important decisions regarding your retirement plan. Generally, you have three choices that allow you to continue to defer income taxation: leave the investments with your current employer, move them to your new employer or transfer them to an Individual Retirement Account (IRA). Of course if you are permanently retiring, the new employer plan is not an option.
Another choice is to cash out your account and pay income taxes on the withdrawal. This is usually not a good alternative since taxes will reduce the amount available for retirement and withdrawals prior to age 59 ½ will generally incur an additional 10% penalty.
There are several factors to consider when making this important decision, including investment options, investment costs, simplicity and the ability to borrow from the plan. Here are four things to keep in mind.
1. Investment Options
Most employer retirement plans have a limited number of investment choices. This can be good and bad. Plans with an abundance of choices can overwhelm the participant with difficult decisions. However, too few choices can limit the participant’s ability to properly diversify assets or select options that reflect their goals and objectives.
It is important to evaluate the options available in the previous plan as well as the new plan. Moving the assets to an IRA allows the participant to invest in a nearly unlimited number of options.
2. Investment Costs
One of the advantages of large employer plans is that investment costs may be lower than those charged in a smaller IRA account. Large employers have more leverage to offer investment classes with lower management fees than an individual can access. However, some larger plans may actually have higher fees than those charged in IRA accounts due to plan administrative expenses.
One way to evaluate the investment costs is to visit the Financial Industry Regulatory Authority Fund Analyzer. This free tool can illustrate the total fees paid over several years and can be accessed online.
If you are like most Americans, you will probably change jobs several times over your lifetime. (Here’s what to leave off your resume when that happens.) Each new employment stop creates a new plan to monitor after you move on. Companies merge, change investment options and change plan administrators.
Each of these changes requires you to set up new investment choices and website logins. Keeping up with all of these changes among several retirement plans can be burdensome. Transferring the assets to a new employer or to a single IRA account can simplify your life since your retirement investments will be situated in one central location.
4. Plan Loans
Employer retirement plans may offer the ability for the participants to borrow from their account (loans are legally available to most employer plans, but not all plan sponsors elect to offer them, and some plan types cannot offer them). Retirement plan loans are limited to less than 50% of the account value or $50,000. While there may be an administrative fee charged for the loan, the interest paid by the participant goes directly into the account, rather than to the plan.
Tax regulations do not allow loans from IRA accounts, so retirement plan loans can be a reason to move assets to your new employer. It is important to recognize that plan loans normally must be repaid upon separation from the employer. Any unpaid balance is considered a taxable distribution, subject to taxation and the early withdrawal penalties previously discussed.
Financial decisions vary for each individual and there is not a one-size-fits-all answer that is right for everybody. You should weigh each of the four aspects of this question to determine the best option for you. (Get a look at your financial health by checking your free credit report snapshot on Credit.com.) Retirement plans and taxation are complex, so we recommend seeking the advice of a certified financial planner and a certified public accountant before making your elections. (Disclosure: I am a financial planner.)
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