This is the first in a four part series designed to help you determine the best way to proceed with your previous employer’s company retirement plans, including 401(k)s, 403(b)s and more. Part 1 | 2 | 3 | 4
What do you think about when you get a new job?
If you’re like most, you’re focused on what the new employer expects from you, learning your position, new processes and dozens of other details that come along with a new position.
This can be a very stressful time for any individual and although it’s the last thing anyone wants to think about, it’s important to remember your company retirement plan(s). These include 401(k)s, 403(b)s, SIMPLE IRAs, Thrift Savings Plans and more. If you’re not consciously thinking about your 401(k) or other employer sponsored plan it can be easy to think “I’ll get around to it later” and eventually forget about it all together.
According to the U.S. Department of Labor, the median number of years that wage and salary workers had been with their current employer was 4.1 years in January 2008. This means the average person will have 7 to 10 jobs in their lifetime. That’s a lot of 401(k)s to keep track of. So what do you do and how do you decide to do it?
Here are your options, each with their own pros and cons:
- Do nothing and leave it it at your old employer (not-taxable)
- Roll it over to your new employer, if available (not-taxable)
- Roll it over to an individual retirement account (IRA) (not-taxable)
- Take the money (taxable)
First let’s address the option that could have the biggest impact if chosen, that is if you withdraw the funds altogether outside of the retirement account. Unfortunately, statistics show this is happening more and more, and illustrates two underlying problems 1. The average American is still experiencing financial stress and 2. A lack of understanding as to how these accounts are to be used and their true intent and purpose.
The tax code was written around retirement accounts to ensure they are used similarly to your pension and Social Security. That is, you build and save funds now to draw regularly from in retirement. So for example, if you planned to retire at 65, live your expected lifespan (we’ll say 90 for this exercise), in a simplified way you’ll draw 1/25 of your savings each year and taxed accordingly. On the other hand, let’s say you are 42, accumulate credit card and other debts, and decide it’s getting out of hand and wish to withdraw $20,000 from a retirement account after changing jobs. In addition to this taking away a significant portion of your future retirement fund, unfortunately there’s more.
If you make $42,000 a year, your federal marginal income tax liability on the withdrawal is 25%, and in Nebraska another 6.84% income tax. Because you’re not yet 59 1/2 (the minimum retirement age according to the IRS, although there can be exceptions to this), there is another 10% tax by the IRS for early withdrawal. So 25% + 6.84% + 10% = 41.84% tax. In other words, you started with $20,000 (100%), paid $8,368 (41.84%) in immediate taxes and kept $11,632. Had you kept that same amount invested just until retirement and earned 7% annually, you would have $94,810 and likely have annual withdrawals taxed at approximately half that rate in the future.
This, of course, has several assumptions included. It does mean, however, that it is rarely the best solution to withdraw the funds altogether. Even some of the highest annual interest rates on credit cards today don’t match the 41.84% income tax. If you feel your situation warrants further analysis to know for sure, it may be a good idea to visit with a Financial Planner.
Read more on your options at the next post in this series, Should I Leave my 401(k) With my Previous Employer?