Posted: June 15, 2020
The COVID-19 pandemic has forced millions of American workers into unemployment with many more worried about losing their job in the near future. Losing your job forces you to think about many tough questions, including where and how you will procure health insurance, and how long your emergency savings will last. But one of the most misunderstood questions is what to do with your employer-sponsored 401(k) retirement account.
Option1: Keep the Plan
If you have more than $5,000 invested in your 401(k), more often than not, you can choose to leave your money invested in that employer’s plan. You will still be able to choose how your money is invested (per the confines of that plan) and take advantage of tax-free or tax-deferred compounding you wouldn’t get in a regular savings account. You won’t be able to contribute any more to the plan but can allow your money to continue growing where it is.
Option 2: Roll Over into an IRA
If you were moving from one job to another, you might have the option of rolling your previous employer’s 401(k) into your new employer’s 401(k). However, with a lay off, you don’t have that transition option. You can, though, open an IRA at most banking institutions and roll the funds into that account.
With a direct rollover, the money from your previous plan is transferred directly into the new IRA without your ever having to touch it or pay taxes on it (unless you choose a Roth, in which case you will pay taxes upon contribution). The distinct advantage of this option is the continued tax-deferral on the full amount of your retirement savings. Luckily, IRAs typically tend to offer more investment options than an employer-sponsored 401(k).
Option 3: Cash Out All or Some of the Account
In general, pulling money out of your retirement account isn’t advisable as (a) withdrawals will incur income tax, (b) pulling out of the market detracts from your money’s compounding power, and (c) you will be hit with a 10% early withdrawal penalty if you are under age 59 ½ and don’t roll the funds into a new retirement account within 60 days. In addition to these drawbacks, if the money is taken as a lump sum instead of in installments, the plan sponsor is obligated to withhold 20% of the funds on pre-tax contributions to cover federal income taxes. The installment approach is not subject to withholding or an early withdrawal penalty, but can be fairly complex to navigate, so you should consult your financial advisor and/or tax professional about exercising this option.
Essentially, if you keep your retirement plan with your previous employer, you can keep your long-term goals on track and grow this tax-deferred income source for retirement.
With the rollover, you can continue to take advantage of tax-deferred or tax-free growth with the potential for more investment options.
By cashing out your 401(k) in a lump sum, you risk your retirement growth potential and incur tax liabilities and early withdrawal fees.
What you do with your retirement account will depend on your financial circumstances, needs, and goals. But when it comes to major money moves, you should always consider your options in the context of your overall financial framework.
At Blue Rock RiversEdge, we understand that the COVID-19 pandemic has changed many Americans’ financial realities. If you have suffered the loss of your job and need assistance protecting your financial future, contact us today to set up a complimentary Discovery Call. Our advisors can help you gain sound financial footing during this difficult transition.