5 costly 401 (k) mistakes to avoid when you quit your job
If you quit your job for whatever reason, you probably have a lot on your mind. You focus on learning a new job or finding a way to replace your paycheck. It’s understandable that knowing what to do with your 401 (k) is often not your top priority.
But when you separate from an employer, you have big decisions to make regarding your old 401 (k) plan. Here are five mistakes to avoid and what to do instead.
1. Leave a small balance with your former employer
Most employers will allow you to keep your money in their 401 (k) plan even after you leave the company. But if your balance is less than $ 1,000, some employers will send you a check – and if you don’t reinvest the money in your Individual Retirement Account (IRA) or a new employer’s pension plan, you’ll be hit with taxes, plus a 10% early withdrawal penalty if you are under 59 1/2.
If your balance is between $ 1,000 and $ 5,000, some employers will transfer your money to what’s called a safe haven IRA. Your money will be invested ultra-conservatively – around 76% of these IRAs are invested in money market mutual funds, which often don’t pay much more than a high yield savings account.
Always check with your plan administrator for your 401 (k) rules before changing jobs. If your employer forces low balance accounts out of their plan, be sure to transfer your money to an IRA or a new 401 (k).
2. Let your former employer send you the money
When you transfer your 401 (k) to your IRA or to a new work plan, be sure to verify that the plan administrator is doing a direct rollover. This means that they will send the check directly to your new financial institution, rather than to you.
If you do an indirect rollover, that is, the check is made out to you, your former employer will automatically have to withhold 20% tax. On top of that, if you don’t reinvest the entire amount into a new retirement account within 60 days, you could face a 10% early withdrawal penalty, while missing out on free growth. tax that makes a 401 (k) so appealing. To avoid any penalty, you will need to calculate the 20% withheld in order to reinvest your entire balance within 60 days.
A direct rollover is by far the way to go to avoid unnecessary taxes, penalties, and headaches for you.
3. Don’t compare alternatives
Even if your employer allows you to stay in their 401 (k) after you quit your job, be sure to consider the alternatives. If you qualify for 401 (k) from a new employer, compare the fees and investment options of the two plans.
Also be sure to check if an IRA is a better option. With an IRA, you can usually invest in any stocks, bonds, mutual funds, and exchange-traded funds (ETFs) you choose, and the fees are much lower. Another benefit is flexibility, especially if you are investing in a Roth IRA. For example, you can access your contributions (but not your income) at any time without taxes or penalties.
4. Cash it out
Cashing in your 401 (k) can be tempting if you’ve lost your job or need extra cash to start a new business. But because of the taxes and early withdrawal penalties, this option almost never makes sense.
Consider the impact of a $ 50,000 withdrawal made before age 59 1/2 if your marginal tax rate is 22% and you live in a state where income tax is 5%. You would pay:
- $ 11,000 for federal income taxes
- $ 5,000 for an early withdrawal penalty of 10%
- $ 2,500 for state income taxes
After taxes and penalties, you would only have $ 31,500 left on a $ 50,000 withdrawal, not counting the tax-free growth you missed.
5. Forget it completely
Believe it or not, it’s pretty easy to forget your old 401 (k). Fintech Capitalize estimates that there are 24.3 million forgotten 401 (k) accounts with $ 1.35 trillion – yes, trillion – in assets.
If you think your old 401 (k) is one of them, the easiest solution is to contact your old employer, as long as they are still in business. Otherwise, try searching for your former employer using the US Department of Labor website or search for your name on the National Register of Unclaimed Pension Benefits.
Once you’ve located your old 401 (k), be sure to take action. Compare fees and investment options to see if your best option is to keep your money where it is or move it to another employer’s plan or to an IRA.