By: Frank Armstrong, CFP, AIF
Hopefully, you won’t be tempted to take the money and blow it. The advantages of deferral are just too great to pass up. Having eliminated that as a possibility, let’s look at whether you might consider leaving your funds with your old employer’s plan.
In the vast majority of cases, the employee is best served to roll over his funds. However, a few job changers will find that leaving their funds in their old employer’s plan may meet their needs. However, each will have to consider their individual circumstances to come to the right decision. Let’s look at the pros and cons.
Reasons to remain in the old plan:
Low costs, and wide menu of investment choices: While it’s generally not the case, a few employers offer superb, low cost plans and subsidize the administrative costs rather than pass those costs on to employees. Better 401(k) or pension plans may offer almost unlimited choices of low cost funds from which a very sophisticated plan can be crafted. If you are satisfied with the plan costs, features, and investment choices, there may be no compelling case to withdraw your funds.
Asset Protection: Qualified pension plan assets enjoy federal protection from most creditors under ERISA (There are exceptions such as divorce settlements under a QUADRO (Qualified Domestic Relations Order)). This same level of protection may not be available under your state laws for IRA’s. Statutes differ from state to state. If there is a significant chance that you might have a claim that exceeds your insurance protection, and your state offers a low level of creditor protection for IRA’s, you might be wise to leave your assets inside a qualified plan.
Early Retirement between ages 55 and 59 1/2 Qualified plans have a big advantage over IRA’s for an employee that needs income from their plan if they have reached age 55 when they separate from service. There is no 10% early withdrawal penalty for distributions from a qualified plan. But, once the money is rolled into an IRA, withdrawals before age 59 ½ it will be subject to the penalty unless you qualify for one of the exemptions (death, disability, etc.) or set up a withdrawal plan under section 72(t). Because the 72(t) withdrawal plans lack flexibility this may be an important consideration. (Note: you may not use this feature unless you worked until age 55 and then separated from service. For instance, you couldn’t separate from service at age 53, wait two years, and then begin taking penalty free withdrawals.)
Reasons to look elsewhere:
Your old employer may force you out: Employers aren’t usually anxious to provide services to former plan participants. The time and money are direct costs of doing business, better spent on existing employees. For instance, keeping track of former employees’ addresses, providing statements and summary plan descriptions and other required overhead mount up to a substantial sum over time. So, a majority of employers require that terminated employees make other arrangements for their accounts.
Limited investment choices: Few 401(k) plans provide the wealth of investment choices necessary to execute a sophisticated asset allocation plan, or coordinate with your other investments not held in the plan.
High costs: Many 401(k) plan costs are unacceptably high. Total costs may easily exceed 3% per year or more. Saving one or two percent a year in plan costs can add up to a fortune over your career.
Control: 401(k) plans offer little control over when and how to use the capital. On balance this is a very good thing. Employees that use their retirement plans to finance vacations or purchase consumer goods systematically plunder their future security. On the other hand, in a dire emergency access to the funds might be valuable. Other plans may make it difficult to re-align investment strategy to meet the participants changing needs.
Consolidation: Today’s mobile work force job hop at a dizzying pace. Some will find themselves with multiple retirement accounts with past employers. It quickly becomes difficult to properly manage all these accounts, design a comprehensive investment plan, or obtain a global view of account performance.
One final consideration: loans
If you have an outstanding loan when you leave your old employer, you must either pay it back, or be taxed on the amount of the loan as a distribution. Loans from pension plans must be repaid by payroll deduction. If you aren’t on the payroll, you can’t continue the loan payments, which will trigger a distribution report to the IRS.