By Sharon Severson
If you have a 401(k) account still being administrated by a former employer, avoid two common—and potentially very costly—mistakes people make in this situation: cashing out the account early or ignoring the account.
Mistake #1: Early Cash-outs—The Wealth Killer
It’s easy to see the downside of cashing out a 401(k) before age 59½. Start with a 10% penalty off the top. This is how the IRS discourages lump-sum distributions for purposes other than retirement. How many deductions from your hard-earned paychecks did it take to build up that 10%?
Also, by cashing out early you’ll pay income tax based on your current tax bracket, which may be considerably higher than if you’d waited until retirement. Employers must withhold 20 percent of the distribution amount to cover anticipated income tax.
In short, early withdrawal is a wealth killer. If you have dire need for the money, see if you’re eligible to take a loan from the plan. You’ll avoid the early withdrawal penalty, and the interest added to the loan repayments goes back into your account.
Mistake #2: Ignoring Your Left-Behind Account
There are good reasons for leaving a 401(k) with a former employer’s plan. It may your best option if you’re currently self-employed or working for an employer that doesn’t offer a 401(k) or similar plan. Or, your former employer’s plan may have better investment options and/or lower fees than your current employer’s plan.
However, left-behind 401(k) accounts can have serious drawbacks. Some plans charge extra fees to accounts of former employees. If you don’t know whether your former employer’s plan does this, find out.
Another drawback is the complexity of monitoring two or more retirement accounts. For some, that’s no problem. But many of us don’t have the time or inclination to regularly review another plan’s investment fund mix and rebalance it based on earnings, projections, and life changes. Potential earnings could be slipping away day by day, while your money stays in underperforming, mis-allocated investment funds.
Having one plan makes it easier to see at a glance whether you’re on track to meet your retirement income goals.
How To Get the Rollover Process Started
Not all 401(k) plans accept rollovers from other plans. Ask your current employer’s plan administrator if you have that option, and if so, how to get the process started.
If you have an IRA already in place with favorable investment options and low fees, you may decide to transfer the left-behind 401(k) to the IRA. In that case, start with the IRA provider for rollover procedures. You may also choose to create a new rollover IRA, but be sure you understand the fees and other costs involved in setting this up.
Keep in mind when you move money from a 401(k) to another retirement account, it’s usually best to have the plan sponsor transfer the money directly to the new financial institution. If the money is distributed to you directly, it can create tax complications.
Sharon Severson is the director of retirement plan products at CUNA Mutual Group. If you have questions about what to do with your former retirement funds, contact CUNA Mutual Group’s Retirement & Investment Solutions Center at: 800.999.8786.