Your 401(K) Rollover Options When Leaving a Job

 |  CEO's Blog

By J.P. Dahdah, Founder & CEO of Vantage

Calculator, pen, and paper clip on top of a numbers graph. 401(k) rollover strategy

401(K) Employee Benefits

Benefits offered by employers matter. Each employee prioritizes them uniquely based on their personal needs. For some, having robust health care coverage is of the utmost importance. For others, working for a company that matches their 401(k) salary deferrals dollar-for-dollar while promoting “free money” ranks the highest. 

 Employers must continually evaluate which perks and benefits are most important while also analyzing the cost of offering them. Conversely, employees spend time assessing whether the benefits offered will meet their individual and family’s needs and wants. 

Benefits packages are a way employers seek to attract talent and maintain loyalty. At the same time, employees search for companies that can deliver a work environment that aligns their professional aspirations and offers good benefits. Not an easy task by any means. 

Let’s take a closer look at the complexity of this conundrum. We will use the retirement plan benefit as our example from employee Jane Smith’s point of view.  

Meet Jane Smith

Jane has been working for ABC Incorporated for 12 years in a role she likes, with people she enjoys being around. She is 60 years old and has been married for 35 years to John, a retired military serviceman.

Jane prides herself on saving into her employer’s 401(k) plan from the moment she became eligible. She knows that participating in her employer’s retirement benefit plan is essential and genuinely appreciates the 3% dollar-for-dollar match she has been receiving.

However, she lacked investing literacy and was not confident in allocating her salary deferrals into the shortlist of mutual funds offered by ABC’s 401(k) Plan Sponsor. 

Similar to millions of Americans, she asked a co-worker what he had selected on his enrollment paperwork and checked off the same options on hers. 

Investing in the stock market always intimidated her. The thought of risking losing the hard-earned money she was saving due to the volatility commonly experienced in the public market. This uncertainty left her feeling stuck and conflicted. Jane did not trust or understand how her money was invested.

 

See Jane’s Predicament

Then, unexpectedly, the globe gets blindsided by a pandemic called COVID-19. The stock market plummets, and ABC’s business and industry experienced a drastic impact. Her worst fears come true within her 401(k)plan, with her account balance dropping 30% in 30 days and her livelihood uncertain.

 After months of trying to save the company, ABC Inc. has no option but to lay everyone off and close their doors. Jane is devastated and overwhelmed.  

Unfortunately, this story is all too common today, with over 22 million Americans facing a similar reality. In moments like these, having a real understanding of all your financial options can make all the difference.  

So, what are Jane’s (or anyone in Jane’s situation) options with the $324,573 balance she has been able to save within her ABC 401(k) account? They aren’t as bad as she thinks.  

See Jane’s 401(k) Options

The most common choice is a Rollover into a Traditional IRA with a Brokerage Firm.

 For over 40 years, Americans have been misled to believe that their only option is to roll the funds to an IRA with restrictive stock market investment options. This option is ideal for individuals who place 100% faith that investing solely in the stock market will enable them to reach their retirement goals. Rolling the 401(k) funds to a Traditional Brokerage IRA will not cause a taxable event. Jane will increase her investment options, but exclusively within publicly-traded stock market selections. 

Do nothing and keep the 401(k) with her previous employer.

For some, it takes additional time to get their bearings before they even remember they have money sitting with a former employer. Understandably, initiating a rollover isn’t top of mind or a priority when you have suddenly been terminated, furloughed, or laid off. It is essential to understand that rolling your funds into an IRA with a broader array of investment choices will better position your retirement savings.  

Request a 401(K) Distribution to her personally

Although a 401(k) isn’t intended to be an emergency fund, it can be a last resort to access money or income when someone has lost employment. If this is the case, you can request a 401(k) distribution to the account holder personally. Keep in mind that this will be a taxable event for any amount you receive as ordinary income. Suppose the account holder is younger than 59.5 years of age. In that case, an additional tax penalty of 10% will apply for early distribution. 

Please note, you do have the option to return some or all the distribution amount to a qualified retirement account within 60 calendar days to avoid the taxes and penalties.  

401(k) Rollover into a 401(k) plan at a new employer.

An imprudent option and the one least implemented. Why? Because it rolls one’s retirement savings from a 401(k) plan with limited investment options to yet another plan with a restricted list of stock market-based offerings. 

The primary goal of any 401(k) rollover is to place your retirement savings into an account that expands your choices and aligns them with your investment appetite.

 Suppose your new employer offers a retirement plan benefit. In that case, you can still enroll in the plan and receive whatever matching they provide through your then-current salary deferrals. To me, choosing this option is like transferring your money from one prison to another when you had the opportunity to release them from jail.  

401(k) Rollover into a Self-Directed IRA

This option offers the most diversification. But, sadly, it is the least known by the American labor force. Some individuals like Jane would prefer to redirect their retirement savings beyond the stock market.

Rolling her 401(k) balance into a Self-Directed IRA enables her to invest in real estate, private loans, private companies, and more. 

Unfortunately, many Americans are misinformed about this option, and most don’t even know it exists. To me, this is the best option because it offers one the ability to invest your retirement savings exactly where you want and feel most comfortable. 

See Jane’s Outcome

Even though Jane’s story above seems woeful, it does have a happy ending.

 A friend of Jane introduced her to Self-Directed IRAs.

With this new option, she could invest her 401(k) rollover funds into what she wants, real estate. She is no longer limited to stocks, bonds, and mutual funds. 

Jane was thrilled because she and her husband, John, wanted to do that for many years. Jane finally has more confidence to meet their retirement objectives.

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