You may not know what to do with your 401(k) when changing jobs, but the last thing you should do is cash it out. Essentially, this is an early withdrawal, which comes with tax and penalties. You have other options, which we will discuss in this article.
- When changing jobs, don’t cash out your 401(k), as you will receive taxes and penalties.
- Once your 401(k) funds are ready to move, one option is to rollover your funds into an IRA tax-free.
- By funding an IRA, you can self-direct your account and make alternative investments, like real estate.
In today’s job market, most employers intend on offering a 3% (or less) raise to their employees – if they offer a raise at all. Taking inflation into account, most workers will see a raise closer to 1%. As a result, workers who want to earn more are leaving for jobs that pay better.
A recent ADP Workforce Vitality report showed that individuals who changed jobs saw a 5.3% increase in their salary. Experts say “job hopping” may be the best way workers can earn more money throughout their career. With today’s current economic climate, individuals should think about changing jobs every 3-5 years.
Cashing Out Your 401(k) Prematurely
When individuals leave their job, they are sometimes given the option to cash out their 401(k), obviously before reaching retirement age. In fact, one in three investors cash out their 401(k) before retirement, according to data from Fidelity. This is presenting an issue, as early withdrawals incur taxes and a possible 10% penalty.
According to Fidelity, the average cash-out for individuals under age 40 is $14,300. After taxes and penalties, many individuals are walking off with less than $9,000. But you do have other options that don’t require tax and penalties.
What to do with your 401(k)
Perform a 401(k) Rollover into an IRA
The good thing about 401(k) plans is that they are extremely portable. In other words, you don’t have to leave your funds in the plan of your old employer. Contributions you made are immediately vested, and can be pulled out when there is a triggering event. In this case, the triggering event would be you leaving the job.
Note: Even if you’re completely vested, there still may be a waiting period before you can remove the 401(k) funds. Typically, the wait is no longer than 30 to 60 days, but there have been instances where the waiting period is as long as one year.
If your employer matched your contributions, there is likely a vesting schedule in place, which may be satisfied after six months to one year, and sometimes three or more years. Every company has its own vesting schedule period. This means the employee must stay with the company long enough to receive the employer’s 401(k) match.
How to Rollover 401(k) Funds into an IRA
Once you are able to move your funds, you can move it to a new 401(k) plan, such as your new employer’s plan if they accept a rollover. You can also convert the funds into a new or existing IRA. Because you are moving funds from one retirement plan to another, you will not be subject to tax or penalties.
Here’s why rolling your 401(k) funds into an IRA is such a good option:
Self-Direct Your IRA for Investment Control
Once you have funded your IRA, you can take it one step further and self-direct your IRA at a passive custodian, such as IRA Financial Trust Company. There are many benefits to self-directing, and it’s far less complicated than one may think.
Essentially, when you self-direct your IRA, you get the freedom to invest in assets you may know better than Wall Street investments. With a Self-directed IRA, you can invest in real estate, cryptocurrency, precious metals and much more.
There are other benefits to self-directing your IRA. Two primary benefits are:
Diversification: When it comes to your investment portfolio, you should never put all of your eggs in one basket. Maintaining a retirement portfolio with assets that do not correlate will better secure your funds in the event that one asset ill-performs. Diversification is so important that industry experts recommend investors buy cryptocurrency, an investment well-known for its volatility. It may be volatile, but a small percentage of crypto in your IRA may sufficiently diversify your investments.
Hedge against inflation: Many alternative investments are hard assets that act as a hedge against inflation. For example, with the rise of inflation typically comes the rise of rental income. Thus, if you own real estate during inflation, you are better protected than if you own stocks or bonds. Gold is also a hedge against inflation. As the value of the dollar decreases, the value of gold will increase.
But even if you don’t rollover your 401(k) funds into an IRA, and then self-direct your account, just make sure you do not take an early distribution, as it can be costly and detrimental to your retirement savings.