Changing Jobs or Retiring? 3 Options for Managing Your Retirement Plan

Most people participating in a 401(k) or other employer-sponsored retirement plan find that the management of it is largely automatic while they are working. But how do those on the cusp of leaving their company to either work elsewhere or retire begin to take the reins and steer their savings plan in the right direction?

If you haven’t yet figured this out, you’re not alone. According to a survey by Cerulli Associates, a research and consulting firm, 25 percent of 401(k) participants 45 and older say they have not yet decided what they will do with their retirement account when they retire. Another 25 percent also say they have not decided, but plan to ask their financial advisor for guidance.

This lack of direction among investors is easily understood. 401(k) plans vary widely, offering very different distribution options. Some allow lump-sum disbursements only. Others might offer partial withdrawals, but this remains a fairly limited option among companies. 

You will find though that most retirement saving plans do offer you a choice of distribution options for managing the money accumulated in your account. Since some choices result in a greater tax liability than others, it’s important to understand the consequences before making any decisions about taking distributions from your plan.

Know your options

Generally, you have three options for managing the money in your retirement plan when you change jobs or retire:

Keep your money in the plan:

• This option is generally available if your account balance was more than $5,000 when you terminated employment.
• You will continue to enjoy tax-deferred compounding of any investment earnings.
• While new contributions are not allowed, you still have control over how your money is invested among the plan's options.
• You must start taking minimum distributions once you are age 72 or later if you continue working past 72 and are not a 5% owner of your employer-company.

When retiring, it might make sense to choose this option if your spouse is still working or if you have other sources of retirement income. Or, if you're starting your own business when you leave your current job, keeping your retirement money in your former company's plan may help protect your retirement assets from creditors, should your new venture run into unforeseen trouble.

Move your money to another retirement account:

• You can move your money directly into another qualified retirement account, such as an IRA, or, if you're changing jobs, your new employer's retirement savings plan.
• With a "direct rollover," funds go directly from your former employer's retirement plan to the IRA or new plan, and you never touch your money. With this method, you continue to defer taxes on the full amount of your plan savings.

Take a cash distribution:

• Have your money paid to you in one lump sum, or in installments of a fixed amount over a set number of years, depending on your plan's provisions.
• Choosing to take part or all of your money when you retire or change jobs is considered a cash distribution, which is subject to ordinary income tax and a mandatory tax withholding of 20%.
• Individuals under age 59½ (55 in some circumstances) could also be liable for a 10% additional federal tax on early withdrawals, in addition to state taxes and penalties.

Understand the tax consequences of a lump-sum distribution

• To avoid paying taxes and/or penalties on a cash distribution, consider redepositing your money within 60 days to an IRA or your new employer's qualified plan. In this case you'd have to make up the 20% withholding from your own pocket, but any excess tax payment would be refunded when you file your regular income tax return. 

• If you're retiring, and opt for the lump-sum option, you will want to determine if there are any favorable tax rules that apply to your distribution, such as the minimum distribution allowance or 10-year forward income averaging if you were born before January 2, 1936.
• To qualify as a lump-sum distribution, you must receive all the money in all of your retirement plans with a company (including 401(k), profit sharing, and stock purchase plans) within a one-year period.

What’s next

Contact your plan administrator for any other options available under your plan. Then be sure to consult a qualified tax and financial planning professional to ensure that your planning decisions coincide with your financial goals.