A 401(k) rollover might be the right decision after a layoff, but not always.
Layoffs at big tech companies have become commonplace lately. If you are caught up in a downsizing, among many challenges, you have a decision your retirement account.
Most 401(k) plans allow you to keep your account at your former employer. Or you can “rollover” the balance to a IRA account or a new employer’s qualified plan.
Perhaps you have 401(k) accounts scattered across multiple former employers?
It might be time to simplify your financial life by consolidating into a single Individual Retirement Account (IRA).
Your 401(k) Options After a Layoff
When you leave an employer—either voluntarily or not—you have several options for handling your retirement account. Options include transferring the balance to an IRA, leaving it at your former employer (if allowed), or cashing out.
Cashing out the account should be a last resort, especially if you’re under age 59 ½. Not only will cashing out set back your retirement goals but will cause you to lose years of future tax-deferred growth. And the distribution will also be taxed as ordinary income and may be subject to a 10% early withdrawal penalty.
Typically, you can rollover your retirement account to either your new employer’s 401(k) program or to a Rollover IRA account. However, if the assets in your retirement account are below $1,000 or so, you may be required to either cash out or transfer the balance.
Minimum Account Balances to Remain
Each plan generally sets a minimum account balance requirement for former employees to maintain an account. Accounts below the minimum are subject to an automated lump sum distribution if not rolled over to a new account.
A few examples from technology companies:
- Apple: $1,000
- Google: $5,000
- IBM: $1,000
- Meta Platforms: $1,000
Other employers don’t set a minimum and will allow any account to remain within the plan. Whereas other employers may require all accounts to transfer or immediately start distributions.
Other Employer-sponsored Defined Contribution Retirement Plans
This article is specific to 401(k) plans. Other employer-sponsored defined contribution retirement accounts include 403(b) accounts for public education organizations and non-profit workers, and Thrift Savings Plan (TSP) if you worked for the military or Federal government.
Transferring a retirement account from one type of plan to another with similar tax treatment (e.g., from a 401(k) to an IRA) is called a “rollover.” If you transfer the account to an IRA, the new account is registered as a Rollover IRA.
Benefits of an IRA Rollover
An IRA rollover is often the most advantageous option, providing simplicity, greater flexibility, and lower costs (sometimes).
Rolling over an employer-sponsored retirement account to your own IRA can simplify your financial life, especially if you have accounts at multiple former employers.
Consolidating your accounts allows you to manage a single account instead of monitoring and dealing with multiple accounts spread out across different providers.
Additionally, you gain flexibility with an IRA.
IRAs typically offer a wider selection of investment options compared to a 401(k) account, including access to ETFs, individual stocks, and a variety of mutual funds. Employer-sponsored accounts usually have a fixed menu of investment options to choose from, and it’s often not possible to hire a professional to help manage your retirement investments within a 401(k) structure.
Brokerage Window
Many large technology companies address this issue by offering a brokerage account option within their 401(k) plan. For example, Apple, Microsoft, and Google all offer a brokerage account options where plan participants can invest in a wide variety of securities.
Investment and plan administration fees
Moreover, investment expenses are often lower with an IRA compared to 401(k) accounts. The fees inside a 401(k) account can be difficult to figure out, but the costs of running these programs are usually passed along to the participants, often through the use of mutual funds with high expense ratios.
Luckily, large tech employers generally offer some of the lowest cost 401(k) plans available. Because of they have lots of participants and high balances, they are able to offer very low-cost investment options. Some even cover the administrative cost of operating the plans.
Fees can be particularly high for retirement accounts sponsored by small employers who don’t have a large asset base to spread costs across.
The Thrift Savings Plan is a notable exception, with fees among the lowest you will find for the investment choices offered.
To Roth or Not Your 401(k) Rollover
Another consideration when doing a rollover is whether to choose a traditional rollover IRA or a Roth rollover IRA.
A traditional IRA is treated tax-wise similarly to your 401(k); you get a tax deduction when you contribute, and earnings accumulate on a tax-deferred basis, but you pay income tax on withdrawals in retirement. A rollover to a traditional IRA is a tax-neutral event.
You fund a Roth IRA with after-tax money (i.e., no tax-deduction for contributions), but you get tax-free withdrawals in retirement.
Roth Conversion
If you decide to rollover your traditional 401(k) to a Roth IRA, it’s important to understand that you will generally owe taxes on the entire amount that you convert.
However, the benefit of converting to a Roth IRA is that your investments grow tax-free throughout your retirement, not just tax deferred. So, compare your current tax rate with your projected tax rate in retirement.
If you expect to have a higher tax rate in retirement, it may make sense to convert to a Roth IRA and pay the taxes now (although predicting future tax rates can be challenging).
It’s also important to note that you should generally only consider a 401(k) to Roth IRA rollover if you can pay the taxes due from other savings. If you withdraw funds from your 401(k) to cover the tax bill, you may be subject to early withdrawal penalties.
In addition to the potential tax advantages, Roth IRAs offer other benefits as well.
After funds have been in a Roth IRA for 5 years, contributions can generally be withdrawn penalty-free (prior to reaching 59 ½) for purposes such as a first-time home purchase or qualified education expenses. Furthermore, unlike Traditional IRAs, Roth IRAs are not subject to Required Minimum Distributions.
It’s important to thoroughly research and understand the advantages and disadvantages of a Roth IRA rollover. Consult with a financial advisor or tax professional to ensure it aligns with your overall financial plan and goals.
Why to Not Move Your 401(k) Account
While consolidating your old retirement accounts into an IRA can offer many benefits, there are some situations where it may not be the best option.
Large companies with low-cost, good investment options. Are you are leaving a large employer that offers low-cost investment options and a wide range of choices? It may be more advantageous to keep your retirement account with that employer. Some large companies negotiate favorable terms with investment providers, resulting in lower fees for participants.
Unique investments. Does your old retirement account include unique or alternative investments that are not available in a traditional IRA? If so, it may be better to leave the account with your former employer. For example, investments in separately managed accounts or collective trusts might not be available to you in an IRA. Generally, 401(k) accounts are liquidated before transferring (e.g., investments are sold, and the cash is transferred).
Company stock. If you have company stock in your 401(k) account you may want to maintain the account. Also, company stock inside a 401(k) account may be subject to favorable tax treatment. Read Save Taxes on 401(k) Distributions for additional details.
Better protection in bankruptcy. In some rare cases, 401(k)—as a ERISA plan—may offer better protection against creditors in the event of bankruptcy compared to IRAs. This can be an important consideration if you are in a financially precarious situation or have concerns about potential creditors.
It’s important to carefully evaluate your individual situation. Consider the specific features of your 401(k) plan before making a decision on whether to rollover or not. Consulting with a financial advisor or tax professional can also provide valuable guidance in this decision-making process.
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