401(k) Options When You Leave Your Employer


Regardless if you are retiring or moving to a new employer, once you leave your current job you will need to decide what to do with your 401(k). You have a handful of choices. I have outlined the benefits and disadvantages of each option below. Your personal circumstances may favor one option over the other. I highly recommend you discuss your options with your fee only financial advisor whenever you transition employment so he/she can help you determine which pathway provides the best choice for your unique financial situation.

1) If you have a balance of $5,000 or greater you can likely leave it in your current plan as most 401(k)’s provide a deferral option.

a) This is the easiest decision and likely no action is required on your part. Although, I am always amazed how many investors choose this default option when there are better choices as described below.

a) Every 401(k) plan has its own unique set of investment options. Your current plan may have a limited choice of investment options such as being overly U.S. centric. We live in a global economy and I believe portfolios should provide a decent amount of international options on both the stock and bond side of investment choices.
b) Many 401(k)’s have incredibly high internal expenses. It is not uncommon to see mutual fund choices with expense ratios north of 1.5%. It is very important to keep an eye on your overall investment expense exposure. The more you can lower your investment expenses, the higher probability you can keep returns compounding for your long-term financial benefit.

Be aware that if your balance is less than $5,000, you will want to take action on one of the below choices as your employer may have the option to automatically cash your 401(k) account out or transfer you to an IRA. Cashing your 401(k) account out can have large tax consequences as outlined later in this article.

2) Rollover your balance to your new employer’s 401(k) plan.

a) This is a good way to consolidate financial assets, especially if you have more than one 401(k) from past employment. I always favor consolidation and simplification where possible.
b) This could be a great choice if you have an excellent set of diversified investment options that are low cost.

a) It is not uncommon for your benefits department at work to occasionally choose a new custodian or a new set of investment options in your 401(k) every few years. You have less control in this situation as you are forced to invest in whatever options are provided. What may look great today could easily change unexpectedly.
b) Your new 401(k) may have poor investment choices, and/or investment options with high expenses.

Most 401(k) rollovers are initiated from the 401(k) you are leaving. Your human resources department or benefits office may require that you fill out a termination/rollover packet of paperwork. Some 401(k) custodians may take direction over the phone. Collectively you and your fee-only financial planner can determine what is the next step to move forward and he/she can help with completing any necessary paperwork.

3) Rollover your 401(k) to an IRA

a) This is typically my favored option. Once you set up an IRA you have the whole investment universe of options to invest in. This could be mutual funds, ETFs or stocks. It is easy to build a well-diversified portfolio when you have such a wide array of investment options to choose from.
b) You have control over your money. You can always move your IRA to another investment custodian if you prefer a change of investment options.
c) You will have control over investment expenses. There are a number of low cost investment options available via no-load mutual funds and ETFs at a number of investment custodians.

a) If you are still working, you may end up with one extra investment account in a separate IRA. This is a minor disadvantage. The benefits of investment selection and cost control provided with rolling your 401(k) to an IRA easily outweigh the disadvantage.

4) Cash out your 401(k)

a) None, other than liquidity if you are in a situation desperate for cash.

a) This is typically the worst decision you can make as any balance withdrawn is a taxable withdrawal. Your 401(k) custodian is required to withhold 20% in federal taxes, but your tax exposure could be higher depending on your marginal tax bracket.
b) You will owe state income taxes on the withdrawal if you live in a state that taxes income.
c) If you are under age 59 ½ you would also be subject to a 10% early withdrawal penalty.
d) If you have an outstanding 401(k) loan balance, the loan would also become a taxable event and be subject to the taxes and penalties described above.
e) You will miss out on any future tax-deferred compounded growth by cashing out your 401(k) today.

There are a couple of other scenarios to be aware of before deciding on one of the above choices:

1) What if you have a loan balance against your 401(k)?
a. You typically have 60 days to pay back a 401(k) loan after leaving employment. After 60 days, your loan balance will likely be considered a taxable distribution and you will be subject to taxes and possibly a 10% early withdrawal penalty if you are under 59 ½ years old.

2) What if you have greatly appreciated employer stock in your 401(k)?
a. You may have a tax preference option called Net Unrealized Appreciation or NUA which allows you to transfer the stock out of the 401(k) and pay ordinary income taxes on the cost basis and capital gains taxes on the gains.  You will want to review this option in detail with your financial advisor and CPA prior to making any decisions.

In closing, I highly recommend you notify your financial advisor of any employment changes which could impact your 401(k) options.  Once he/she is aware of your options, they can help you determine what the best course of action is for your personal financial situation.  Your financial planner can also join in a conference call with your benefits department and/or 401(k) custodian to make sure you both understand all of your options and what steps are required to move forward.

5 Common 401k Problems Investors Make

401k - Steve Reh - August 2016

Are You Making The Most Of Your 401k Options?

This article was written by a special guest author and colleague, Stephen Reh.  Stephen Reh CFA, MBA, CFP® is the founder of Reh Weath Advisors LLC and https://investwithsteve.com/, a fee only financial advisor in Southern California. Stephen is a member of the National Association of Personal Financial Advisors like David J. Fernandez, CFP® and specializes in financial planning and investment advice.

First, I wanted to thank David J. Fernandez, CFP®, your Fee Only Advisor in Scottsdale, for giving me the opportunity to discuss common things I see when looking at investor’s 401k accounts. Similar to David, I help individuals and families with retirement and financial planning needs. One of the areas we commonly see is 401k retirement accounts. Below are some common issues, we run into.

Turning Down Free Money

You would be surprised how many employees say, “no thank you Mr. Employer, I don’t want your free money.” If your employer offers to match your contributions and you elect not to contribute, you literally are giving away free money. Even with 401k’s that have inferior investment menus or high costs, the benefit of the company match will almost always outweigh any negatives the plan might have.

Solution – At least contribute enough money to maximize your employer match. We can help you craft a plan that maximizes your employer match and how it fits into your overall investment plan.

Naïve Diversification / Kitchen Sink / Just Pick Everything

A participant is sometimes knowledgeable enough to know they want diversification and they don’t want all their eggs in one basket. What do they do? They pick everything on their 401k menu. The problem arises in that the person really doesn’t know how much risk they are taking or what they are invested in. If there were a lot of high yield bond funds on the menu, a participant may have way too much risk with high yield bonds. You can also have times where the plan has significantly more stock choices than bonds choices which may result in a portfolio that is not appropriate for the investor.

Solution – Do your research and develop an investment plant that includes sound asset allocation and diversification.   Need help creating that plan, contact a fee only advisor and they can help save you time and build an appropriate model for you.

Picking the Winners and Selling the Losers

This one sounds good on the surface but what this means is that you are likely late on buying the funds that have done well and late selling the funds that have done poorly. You also run the risk of having a very concentrated position at the wrong time. If you invested in the top funds in the late 1990s, you likely were overexposed to technology. Prior to the financial crash, if you picked the top funds, you were likely overexposed to commodities and financials.

Solution – Do your research and develop an investment plant that includes sound asset allocation and diversification.   Need help creating that plan, contact a fee only advisor and they can help save you time and build an appropriate model for you.

Assuming that Target Date Fund Matches Your Risk Tolerance

The Target Date funds start out aggressive and will get more conservative over time. However, there is absolutely nothing that matches a participant with the risk level they are comfortable with. The match is entirely dependent on either your age or the age you want to retire. If you are conservative and young, your target date fund is likely too aggressive for you and you might panic in a downturn. If you are older and have a high tolerance for risk, you might be disappointed that your target date fund did not perform better. Another common issue I see is a young investor picking a target date fund with a slightly “older” age. The problem here is most of the funds are fairly aggressive until you near retirement.   So by picking what you thought was a conservative portfolio, it did not make a difference until decades later.

Solution: Build a portfolio that matches your risk. A fee only advisor like David can help build a portfolio that matches your needs and risk.

Forgetting to Rebalance / Ignoring Your Plan

Some people have not rebalanced for years. By not rebalancing,   the portfolio might no longer be diversified and you could be taking excess risk or potentially not enough.

Solution: Check your plan at least annually to verify if it meets your needs. Not sure it meets your needs? Contact a fee only financial advisor such as David to help keep your 401k on track.

David and I help investors every day to build portfolios that will meet their needs and goals. If you would like help making sure your investment plan is on track to meet your needs at a risk level that’s appropriate, give David a call.