Changing careers is an exciting time, but benefits can quickly get complicated–setting up payroll, enrolling in health insurance, and tapping into retirement benefits are a lot to heap onto your plate while you’re learning a new job. To help make your transition a little less stressful, we spoke with our team of experts at Camden National Wealth Management for their advice on options when it comes to handling your 401(k) plan from your previous employer.
Before we dive in, let’s take a moment to review the basics of a 401(k)…
A 401(k) plan is a retirement benefit offered by many employers. Employees contribute to their 401(k) account through payroll deductions, and your employer may even match some or all of your contributions. Contributions to a 401(k) are made pre-tax, meaning that you don’t pay taxes on the money you contribute until you withdraw the money from the account (typically after age 59½, when withdrawals would be taxed as ordinary income).
When you change employers, it’s natural that you’d be wondering to do with the 401(k) account you set up at your previous employer.
In general, there are four ways to handle a 401(k) account that you contributed to while working for a previous employer. When weighing your options, it’s important to look at your financial situation, revisit your goals for retirement, and perhaps consult with a financial and/or tax advisor. Let’s take a high-level look at the options:
- If your new employer offers a 401(k) plan, you may want to roll your existing 401(k) assets over into the new plan.
This is a frequent choice for people when they change employers, as you’re consolidating all pre-tax 401(k) assets into one account. When you rollover a 401(k) into a new 401(k) plan, you avoid any taxable events or penalties. Then, with your new employer’s 401(k) plan, you can continue making regular contributions, growing your nest-egg, and—if possible—taking advantage of any match your new employer may offer.
Be sure to speak to your new 401(k) plan sponsor about any additional advantages you may have with a 401(k) rollover.
- Another option is to rollover your 401(k) assets into an Individual Retirement Account (IRA).
When changing employers, some people choose to rollover the balance of their 401(k) account into an IRA. Rolling over into an IRA is a tax-free event. Different factors such as your age, retirement timeline, and marital status can go into the decision. If your new employer does NOT offer a 401(k) plan, this may also be a helpful way to continue making contributions to retirement savings. Key things to remember about IRAs are:
- IRAs have flexibility. You’re able to choose where you open the account and what investment vehicles you’d like to use. You may also choose to work with a financial professional on your investment strategy.
- After the rollover has taken place, any future contributions you make to an IRA account are after-tax. There is also an annual contribution limit. In 2021, the contributions limit for IRAs is $6,000 annually (or $7,000 if you’re over 50).
- After you reach age 59½, any withdrawals you make from an IRA are taxed as ordinary income. Be sure to consult with your tax advisor as there may be an opportunity for tax deductions.
- When it comes time to draw on your 401(k) in retirement, it may be beneficial to roll the funds into an IRA first, though this is not required.
- We can help you set up an IRA and recommend an investment strategy that is right for you.
- You may also choose to keep your 401(k) with your former employer AND create a new 401(k) with your new employer (if they offer a 401(k) plan).
There are certain situations where you may want to keep your money in your former employer’s 401(k) plan (for example, you may have company stocks that cannot be rolled over).
Keep in mind, however, that if you decide to keep a balance with your former employer’s 401(k), you won’t be able to continue making contributions to that plan. You’ll only be able to contribute (through payroll deductions) to the new account you set up with your new employer’s 401(k) plan.
It’s a good idea to check in with your former employer’s HR benefits department and confirm how they handle these situations. If you have a relatively small balance in your former 401(k) account, your former employer may choose to cash out the account (with a penalty at your expense) or automatically move your 401(k) balance into an IRA.
- It’s an option to cash out your 401(k)—though ill-advised if you’re under the age of 59½
When you take a full distribution directly from your 401(k), 20% is automatically withheld for federal income tax (whether you end up owing 20% or not) in addition to a corresponding state tax (5% in Maine). If you’re under the age of 59½, there will be additional penalties for withdrawing funds early—and this can be very costly.
Saving for retirement is a critical part of your financial health, but it’s natural to feel overwhelmed by the options and tax implications. Getting good advice now will help you meet your goals in the future. If you have additional questions or would like assistance with your unique situation, please be sure to speak with your tax and/or financial advisors for guidance, or reach out to your local Camden National Bank banking center to get in touch with a member of our Camden National Wealth Management team.