Category: General

Have money in a 401k at an old employer? What to do with your old 401k.

What to do with your balance in an old employers 401k or retirement plan.

Most people don’t work for one employer their entire lives anymore. The days of people relying on a pension from their employer are seemingly coming to an end.

401k’s came into existence in the 1980’s. Since then most employers have made the move from defined benefit pensions to defined contribution 401k’s.

  • Defined Benefit– A type of retirement plan in which an employee’s pension payments are calculated according to the length of service and the salary they earned at the time of retirement.
  • Defined Contribution– A type of retirement plan in which the employer, employee, or both make contributions on a regular basis. Future values fluctuate based on investment earnings and contributions.

Back in the 1980’s, 401k’s were presented as giving employees the power to choose their own investments. In reality, they were oftentimes a modest cost savings to employers over their defined benefit counterparts since all employers aren’t required to contribute to an employee with a 401k. Typically the total employer contribution amount is lower as the employee is expected to contribute as well.

The 401k is designed for employees to save for themselves for retirement. The money the employee contributed can go with the employee when they leave the place of employment. The employer contribution is also eligible to go with the employee if the employer contribution is vested.

34% of employees say they plan to leave their current employer in the next 12 months according to Mercer. So wondering what to do with an old 401k balance can come up quite often as there are many people changing jobs that have balances in an old employer’s 401k.

There are four options that may be available to you when it comes to your old 401k: You can leave your account alone, roll it into an IRA, roll it into your new employer’s plan, or cash it out. We will walk through each here.

1)   Keep your money in your former employer’s plan.

If you have a 401k balance over $5,000 you legally cannot be forced out of the 401k plan. If you have under $5,000, your employer has the option to cash you out of the plan which can potentially cause you issues you may not be aware of.

Good things:

  • You don’t have to do anything
  • You are already set up to view your account.
  • You can take penalty-free withdrawals from an employer-sponsored retirement plan if you leave your job in or after the year you reached age 55 and expect to start taking withdrawals before turning 59½.

Not So Good Things:

  • Once you’re no longer an employee, your access to your money may be limited, you are no longer eligible for any loans, and you cannot add more money to the account. You may have to go through your old employer for any changes or requests.
  • You have to remember to make sure your old employer has your current information such as your mailing address. This can be annoying if you have multiple 401k balances sitting out there. Plus, if your old company gets bought, changes plan providers, or the HR person changes, you may not have easy access to your login information or your new account number.
  • Investment advice is typically done at employee education meetings at the business, so once you are no longer employed typically you aren’t attending these meetings.
  • Plan may offer expensive investment options or lack investment options you want. Do you know the administrative costs the 401k passes to the participants? What about your mutual fund expense? See my blog about 401k fees here.

2)   Move your money into an IRA

This choice gives you the most control and flexibility. With a 401k plan, the employer chooses the investments that are available in the plan and has more rules, with an IRA you aren’t limited to what the employer has chosen for the plan.

Good Things:

  • Working with a financial advisor, you will have access to advice for your certain situation. This can be especially helpful if your 401k has been at your old employer for years and you are just now taking a look at the investments you were allocated into. It is also helpful if you are close to retirement age, to sit down with someone to discuss a course of action.
  • Ability to combine multiple employers’ old 401k accounts into one IRA.
  • Greater control over your investment expenses. 401k investment fees are in a participant fee disclosure, and in some cases they’re higher than what you’d pay for comparable investments outside the plan.
  • Greater freedom to name beneficiaries. The beneficiary of your 401k plan, by law, must be your spouse; you have to obtain a signed release from him or her if you want to name anyone else. An IRA can be more flexible.

Not So Good Things:

  • Taxes will be withheld unless you move the money from your 401k to an IRA via a trustee-to-trustee transfer. Not all recordkeepers will do this, and sometimes the check is mailed to the employee rather than the new IRA custodian. You have to make sure the money is in the account within 60 days, so the disbursement of funds aren’t treated as a withdrawal by the IRS.
  • It can take a bit of effort to figure out how to move the accounts by yourself.

3)   Move your money into your new employer’s 401k

You should certainly contribute to your new plan if your employer offers a match, but should you transfer your old account into it?

Most 401k’s allow you to transfer old employer’s 401k balances into it. Not all do though, so you should check with your new employer before you do so.

Good Things:

  • Consolidating your retirement money makes it easier to view and manage. When you’ve left a retirement account at a company you no longer work for, you may pay less attention to its performance or downplay its importance in your overall picture.
  • The new plan may offer more attractive investment options than the old one, as well as additional services, such as access to a financial advisor.

Not So Good Things:

  • The financial advisor on the plan may not be a fiduciary. The advisor may just do group meetings with little access to personal advice for your specific scenario.
  • The new plan may offer fewer investment options or investments that don’t meet your needs.
  • Fees can be high in 401k plans; do you know the administrative costs the 401k passes to the participants? What about your mutual fund expense?
  • Paperwork to move the money can be confusing and requesting certain documents and letters from the old 401k plan sponsor/recordkeeper can be tedious.

Generally, the smartest move is to evaluate the fees charged by the investments that you’d use in each plan and go with the plan that offers the lower-cost options. Again, the participant fee disclosure might not have all plan fees listed and it isn’t the easiest to determine.

4)   Cash out the account

Good Things:

  •  It’s money you can use for other purposes.

Not So Good Things:

  •  You could no longer have any retirement savings.
  •  Distributions from your 401k could also push you into the next tax bracket, giving you a bigger tax bill.
  • You will owe income taxes on your money.

If you’re in a 28% combined federal and state tax bracket, for example, and cash out a $40,000 account, you’ll have only $28,800 left after taxes. If you are under 59.5 there would also be a 10% penalty which would leave you with $24,800, far from the $40,000 you were expecting.

Not all of these options are available in everyone’s situation. If you find it confusing or overwhelming, I’d be happy to speak with you regarding your situation to help you with the decision, or to start the process.

The content of this article is provided for information and discussion purposes only. It is not intended to be a financial recommendation and should not be the sole basis for your investment or tax planning decisions.

Understanding the Required Minimum Distribution

The Required Minimum Distribution

If you turned 70 on or before June 30th, 2018, you have moved into a new phase of retirement planning.  The IRS may now require that you take a minimum distribution from your retirement accounts beginning this year.

What is the RMD and when does it need to be taken?

RMD is an amount of money that is required to be removed from your qualified accounts each year.  The IRS allowed for money to be added over the years into a qualified retirement account [IRA, 401(k), 403(b), etc.] before tax and allowed the assets to accumulate tax deferred. The RMD is a way for the IRS to make sure that the account that you have deferred tax on to this point is withdrawn over your lifetime, or the lifetimes of your beneficiaries, so that the amount becomes taxable.

Each person with a qualifying account is required to make their first distribution by April 1st of the year following the year they turn 70.5.  After the first year, you are then required to take a distribution from the account by December 31st of each following year.

Example:

Stan is 70.5 on April 30th, 2018 and is now subject to the RMD rules. He is required to take a distribution for 2018 on or before April 1st, 2019.  He is also required to take a distribution for 2019 on or before December 31st, 2019 and so on.

If you are already taking a distribution that is greater than or equal to your RMD for a given year then that distribution completes your requirement.  If you are taking less than the RMD for a given year you will need to increase your distribution for that year to meet the minimum.  You can take this distribution in one lump sum, in monthly increments, or in any other fashion you like as long as it is all taken by the required date.

Which accounts does it affect?

Accounts that had assets added to it on a pretax basis and that have grown tax deferred are going to be subject to the RMD rules.  This includes IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s and 403(b)s.

If you are working past 70.5, you cannot make contributions to an individual plan and you must start the RMD for those plans.  However, if you are 70.5 years old and still working at an employer that has a qualified employer plan, you may add to this plan and you do not have to take an RMD from that plan as long as you are not more than 5% owner of the company.

If you have both account types, are 70.5 and still working, you do have to take an RMD from your individual accounts but you do not have to take from your employer plan.  You are allowed this exemption to the rule while you are working.  Once you stop working the employer plan is now subject to the RMD rule.

Example:

Stan is still working with an employer that has a 401(k) and he has a balance in the plan of $500,000. He also has $500,000 in an IRA.   The IRA is going to be subject to the RMD and he will be required to take the minimum distribution from the account annually.  The 401(k), on the other hand, is not subject to the RMD because he is still employed at that company that holds the 401(k).

When Stan leaves the company both the IRA and the 401(k) are subject to the RMD rule and he is now required to take the minimum from both accounts.  It makes no difference whether Stan leaves the money in the 401(k) or moves it to the IRA, the RMD amount is the same and is required for both accounts.

How is it calculated?

Many people believe that the RMD is calculated as a percentage of the account value but that is not the case. To calculate your RMD simply take your account balance on December 31st of the previous year and divide it by the number that corresponds to your age at the end of the year on this IRS RMD Table.  Each individual account has its own RMD so you will want to calculate each account separately. If you are not comfortable performing the calculation yourself or want to double check, there are many online RMD calculators available.

Example:

Stan turned 70.5 on April 30th, 2018 (so he will be 71 by December 31st, 2018).  Let’s also assume that he is not working and has an IRA with an account balance of $500,000 on December 31st, 2017, held at one custodian and another IRA account with $200,000 on December 31st, 2017, held at another custodian. To calculate his RMD for 2018 he would go to the IRS RMD table and find the divisor that corresponds to his end of year age of 71.  Use this divisor to divide the account balances as shown below.

2018 RMD

$500,000/26.5 = $18,867.92

$200,000/26.5 = $7,547.14

How do I take it?

Stan would be required to take a total of $26,415.09 ($18,867.92 + $7,547.14) from his accounts by April 1st, 2019. He is only required to take the total, it does not matter which account(s) he takes it from and in what proportions.  He could take the amounts listed from each account or he could take all from one and none from the other.  As long as he takes the total by the deadline the IRS mandate is satisfied.

As discussed above, this first distribution is for 2018 and he has until April 1st, 2019 to take it.  After the first distribution, he is required to take an annual distribution by December 31st every year after, including December 31st, 2019.  Note that he will recalculate the RMD amount each year using the same method discussed above.

Taking two RMDs in a single tax year could have the effect of some income being subject to a higher marginal tax rate, reduced deductions or a change in the treatment of capital gains, qualified dividends and social security.  Taking that first distribution by December 31st, 2018, would have helped him avoid these pitfalls but would have increased his income in 2018, possibly causing their own pitfalls.  Speak to a trusted advisor regarding your situation to make sure you are making the best decision for you.

It is the responsibility of your custodian to calculate and report the RMD to you each year, but it is your responsibility to make sure that it is met.  Also, it is the account holder’s responsibility to verify that the amount given to them by their custodian is correct, so make sure to use the above-mentioned table to verify your RMD.  If you fail to take your RMD or any part of the RMD in a given year, you will be subject to a penalty on the undistributed amount of 50%.

Example:

Stan has an RMD of $26,415.09 for 2018 but has been busy with distractions this year.  He knows the amount but forgets to take the distribution by the April 1st, 2019 deadline.  He is now required to take the full RMD of $26,415.09 but he is also subject to an IRS penalty of $13,207.55 (50% x RMD).

The penalty will be taxable income to Stan which may affect the taxation of other income sources or could bump him to a higher tax bracket.  This is an easy mistake to make but a very expensive one.

What can I do with the money?

Once you have paid tax on the distribution you are free to spend it, save it or reinvest it in another, non-IRA account.  The point of the IRS requirement is not to have you spend the money, it is to have you pay tax on the money.

If you are charitably inclined, the IRS does allow your RMD (or a portion of your RMD) to be directed to charities of your choice.  If you distribute the funds directly to the charities through your custodian this amount will not be included in your taxable income but will satisfy your RMD for that year.  This is known as a Qualified Charitable distribution (QCD).  Be sure to speak to an advisor regarding this strategy as there are certain limitations that may affect the deductibility of the donation.

The RMD rules can be confusing with one account but, if you have more than one account or you are still with an employer where you have a 401(k), they can become downright overwhelming.  Be sure to give yourself enough time before your deadline to understand your situation so that you can satisfy your requirement and avoid a costly penalty.

*Stan’s example is for educational purposes only. Each individual situation is unique. The piece should not be seen as a recommendation.

Welcome –

Martin Financial Welcomes Sarah Cattan, Micah Lagowski, and Morgan Williams! 

We’ve been growing, and have added three new staff members to our team at Martin Financial Group.

Click on their picture to learn more.

 

 

Our New Blog

Let’s be honest, personal finance can be confusing.  There are taxes, investments, estate planning, and insurance concerns to think about, just to name a few.  Within each of these topics are questions to ask: IRA or ROTH IRA; am I taking the right tax deductions; should I pay off my mortgage before I retire; what is a trust and do I need one; have I saved enough; and the ever dreaded, am I going to run out of money.

On top of all of that there is the economy, the Federal Reserve, geopolitical issues, debt ceilings, and government shut-downs that flash in front of you all day long through all sorts of outlets.  There is no shortage of information available today, but the challenge is filtering down all of this “information” to what matters to you.

The intent of this blog is to introduce you to topics you may not be familiar with and expand your knowledge on topics you already know and would like to learn more about.  I welcome your feedback and questions, because my hope is this blog will spark more conversations about what affects and interests you most.

This blog will take the place of the emails that you occasionally receive from me so that each post is archived in one place for you to revisit and share with friends and family.

Enjoy