A job change often opens up new avenues, both in terms of experience and earnings. Most people look for a higher salary when they’re making the switch, but does that always translate into greater savings?
Surprisingly, this doesn’t happen too often. You need to make an effort to help your retirement savings stay at par with your increased earnings.
Keep Your Personal Finance Strategy on Track with these Tips
When you’re changing jobs, there’s a lot to deal with, and managing your retirement nest egg doesn’t typically make it to the top of the list.
However, it should be a priority. After all, the money you’ve saved in IRAs, 401k and pension plans is what will keep you financially comfortable and secure after you hang up your boots.
Potential taxes and penalties can have a huge impact on your retirement savings unless you handle your 401k savings correctly while switching jobs. Here are some simple ways to keep them from being affected:
Don’t Make a Withdrawal
We get it. Changing jobs is tough, and you may need some money to help tide you over. However, dipping into your retirement fund should be the very last option.
If you cash out your 401k before the age of 59½, not only do you need to pay income tax on the distribution, but also an early withdrawal penalty of 10% on the amount. In addition, you lose out on the tax-deferred gains that money would have earned you if it had been left in the account.
Leave Your 401k in Place
It’s easier to leave an old 401k with your prior employer, especially if you might not be with your new employer for a long period or have not yet found a new job. Check if there are any restrictions with this option, though. For instance, you may not be able to continue with the plan if the balance is less than a certain amount.
Also, remember that this option doesn’t let you stay up to date with investment options or changes to defined contribution plans, since you’re not an active employee any more.
Rollover to a New 401k
It might make more sense to rollover the funds from your older 401k plan if your new employer also offers one and you plan to work with them for a while. However, make sure your new employer will allow you to rollover an existing defined contribution plan.
Consider the benefits offered by both plans before deciding whether to leave the old 401k in place. Consult a professional for advice if you aren’t sure about your next move.
Alternatively, Rollover to an IRA
You can also rollover the funds from an old 401k into an IRA, which allows you greater flexibility in terms of how and where your money is invested. This is particularly smart if you think you might be switching jobs again in the near future.
When you rollover to an IRA, it’s up to you to choose which investment options your funds will be placed in. Your retirement savings will continue to grow on a tax-deferred basis, but you can diversify your investments to spread the risk and maximize your long-term gains.
Choose a Direct Rollover
With an indirect rollover, where you receive a check for your 401k balance from your old employer, there’s a 20% federal income tax withholding on the gross amount. You need to make up for this with your own money while depositing the money into an IRA. If you don’t, additional income tax and penalties will apply.
You also need to make the deposit to your new IRA within 60 days, otherwise you risk facing penalties and taxes. If you’re opting for a rollover to an IRA, make sure you choose the direct rollover method to avoid being hit with unnecessary losses, as well as minimize the hassle involved.
When you’re dealing with a job change, carefully consider all the options available and continue to contribute to your retirement plan. Most companies offer personal finance and investment planning, so look for expert guidance and assistance if you’re confused about the best move.
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He regularly writes for blogs at MoneyForLunch, Biggerpocket, SocialMediaToday, NuWireInvestor & his own blog for Self Directed Retirement Plans. If you need help and guidance with traditional or alternative investments, email him at [email protected] or visit www.sdretirementplans.com.