Ready for a change? Don’t Forget Your 401(k)

Ready for a change? Whether you’re switching jobs, taking time off for family, or pursuing further education, you may receive a significant sum from your employer’s retirement plan. Many people focus on their next opportunity and overlook their retirement savings, leaving money behind. Deciding what to do with these funds is crucial, as your choice can have a lasting impact on your financial security. Below, we share an overview of the main options for handling a retirement plan distribution, along with the pros and cons of each.

What are Your Options?

1. Keep Your Money in your 401(k) Plan

If your current retirement plan allows it and you are satisfied with your plan's management and investment choices, leaving your money where it is may be a smart option. When you leave your retirement money untouched in your current retirement plan, you will defer having to pay current income taxes and avoid a possible early withdrawal penalty. Your money will continue to benefit from potential tax-deferred growth. You will only pay taxes when you withdraw the money at retirement age.

Just as importantly, this option allows you to continue to maintain full control over your account. You have the flexibility to move the money elsewhere if you choose to do so later.

2. Roll Your Money Over into a New Plan

You can take the money from your current retirement plan by rolling it over into a new individual retirement account (IRA) with a financial institution or, if allowed, into your new employer's retirement plan.

With both options, your money will continue to benefit from potential tax-deferred growth, no income taxes will be due on the transfer to the new plan, and you will retain full control over how your money is invested.

It is extremely important that you ensure that your retirement plan account balance is rolled over directly into an IRA or to your new employer's tax-deferred retirement plan. This is known as a direct trustee-to-trustee transfer, and it ensures that your money remains tax deferred and that you won't get hit by a 20% tax withholding. If you do not opt for a trustee-to-trustee transfer, the check for the funds in your old plan is payable to you, and the plan administrator is required to withhold 20% of the total for estimated tax payments.

3. Opt for a Combination of Lump Sum and Direct Rollover

You also have the option to take a portion of your retirement plan payout in cash while making a direct rollover of the remainder to an IRA. The money you roll over to the IRA will potentially continue to grow tax deferred, while the portion of the payout you receive in cash will be taxable to you in the year that you receive it.

While your rollover funds continue to grow tax-deferred in an IRA, you will also have access to your money at any time.

4. You Can Take the Money in Cash, But Be Careful

The opportunity to access what could be a large sum of money can be a very appealing option for many people. In some ways, it can appear to be a little like coming into an inheritance or winning the lottery. However, if you are ever tempted by this option, you should know that it has more drawbacks than advantages.

The biggest drawback is that you will have to pay income taxes on the cash payout at your ordinary income tax rate in the year you receive the money. Your former employer is required by law to withhold 20%¹ of your distribution as partial payment on your tax bill for the year before you even receive the check Also, the distribution may have a possible early withdrawal penalty that your former employer is required to withhold.

Another overlooked aspect of taking a cash payout from your retirement plan is that you'll have to start all over again when it comes to your future retirement security. The reality is that when it comes to saving for retirement, time is your friend. The longer you save and invest, the more you can potentially benefit from the power of tax-deferred compounding. By emptying your retirement savings account, you may find it difficult to make up for that lost time. It could also mean that you have to delay retirement, work part-time while retired, or live on less after you stop working.

Need Help Deciding?

Since every situation is unique, it’s always a good idea to talk to a professional before making any decisions. Our team at the Popular Retirement Center can assist you, just email us at educacionretiro@popular.com. And, if you have a 401(k) plan with Popular, you can also count on our experts at TeleBanco Popular® for guidance on your retirement plan. Give us a call at 787-724-3657 (press option 2 three times).

 

 

¹ A preferential withholding and taxation rate of 10% may apply if: 1) The plan is under a trust deed of PR or the US with a trustee located in Puerto Rico acting as the plan’s paying agent, and 2) 10% or more of the assets in the participant’s account were invested during the current year and the following two years in property located in Puerto Rico, as designated by the Secretary of the Treasury (Puerto Rico Internal Revenue Code, Section 1081(b)(2)(B) and Section 1021.02(a)(2)(B).

The information and general descriptions found in this article are designed to help you understand some of the factors you should generally consider when evaluating the appropriateness of any strategy or investment within your retirement plan. Any description included is for informational and educational purposes and for your independent consideration only; it is not to be regarded or viewed as advice or as a suggestion to take (or refrain from taking) any particular action. By providing this information, we assume that you can evaluate this information and the general descriptions found here to exercise your independent judgment.

Banco Popular de Puerto Rico, its subsidiaries and/or affiliates are not engaged in rendering legal, accounting or tax advice services. If legal, accounting, or tax advice services are required, you should seek the services of a competent professional.

Investment products are not insured by the FDIC, they are not deposits or obligations of, nor are they guaranteed by Banco Popular, its subsidiaries and/or affiliates. Investment products may lose value. Some insurance products may lose their value.