You've found a new job and are leaving your old company. This is good news. The salary is higher than your old job; the work is more interesting and the commute shorter. However, you still face the question of what to do you with the funds in your old company's 401(k), 403(b) or 457 plans?
You have several options. Unfortunately, many workers choose the worst one. They cash out the money in their retirement plans and spend the funds, maybe to pay down credit card debt or take an expensive vacation. Fidelity reported that of the 800,000 or so workers who left a job in the first nine months of 2013; 35% cashed out their former employer's plan. They failed to roll it over into a new 401(k) or IRA.
Doing this might seem like fun. After all, you've worked hard to save money. Why not enjoy it? Problem is, cashing out your retirement savings plan comes with significant penalties. First, your former employer will withhold 20 percent of the money you've saved to pay federal taxes. That is right; you'll receive just 80 percent of the money that you've saved.
Secondly, if you are under 59-and-a-half when you cash out your retirement savings plan you'll have to pay a 10 percent penalty on the money you withdraw. Finally, when you start working your new job, you'll have to rebuild your retirement savings from scratch. Depending on your age, this can put a serious crimp in your retirement plans.
Fortunately, there are other, better, options.
When moving from one company to the next, you have the choice of transferring the funds in your previous employer's retirement savings plan directly into a traditional IRA. This is a direct rollover, and there are several reasons why this is a better financial choice than cashing out your retirement savings plan.
First, there is no 10 percent penalty for doing this no matter your age. That is because you are not taking out the funds in the plan. They are just moving to a new retirement savings vehicle. Secondly, you will not lose 20 percent of your retirement savings to federal tax withholding. This means that 100 percent of the funds that you saved while working for your previous employer remain yours; a definite bonus come retirement time.
You might also find that your traditional IRA brings with it several new investment options. You can invest the funds in your IRA in stocks, bonds and several other investment types.
Bringing Your Money With You
You might also be able to bring the dollars from your former employer's retirement savings plan to your new company's retirement plan. You can then invest those dollars in your new employer's retirement savings plan and continue growing your retirement nest egg in a single place.
Be careful, however. Not all employers will allow you to transfer funds from a former retirement savings plan into theirs. Be sure to speak to your new employer's human resources department to find out if this option exists. If it does, it is a good one. Again, you will not pay any penalties, and you will not have to worry about federal tax withholding. Best of all, you will not have to start building your retirement savings from scratch.
Leaving it Alone
There's a final option available to employees as they move to a new company: They can leave the money they've built at their past company in that company's retirement savings plan. Most companies will let you do this as long as you have at least $5,000 in their retirement savings plan.
This option comes with one big benefit: It is easy. You will not have to make any plans for the money you've built up. You can let it sit where it is. This might be a good choice if you are happy with your previous employer's plan.
There is a drawback, though: You cannot add new dollars. You also might lose touch with what is happening at your former employer. What if the manager of the retirement savings plan has switched to an investment mix that is less successful? You might not even know it until the value of your retirement account begins to fall.
If you are starting on a new career with a new employer, be sure to research the options for your retirement savings plan. Moreover, don't make the big financial mistake of taking the money you've saved and running. That may seem like the easiest choice, but it is the one that makes the least monetary sense. You've earned that money. Don't waste it.