Most Americans are generally familiar with the idea of planning for retirement, whether it's through an employer-backed 401(k), a private IRA, or some other investment vehicle. But not all of those who toil away building a 401(k) or other account understand what's going to happen to it if they leave the company.
In talking about the big changes made to pension and retirement plans in the last couple of decades, one thing analysts are stressing is that people tend to have a lot more job volatility than they used to. In other words, more of us will change jobs several times in the course of a career. That's part of what has led to the disappearance of the "three-legged stool" that was often advised for workers lucky enough to have a pension, private funds, and Social Security credits. But it's also an issue that will create a lot of confusion, because although people may agree to save for retirement in an employer plan, they may not have a clue what to do with that money if they decide to quit.
Workers who are leaving a company can take their retirement money with them, either moving it into a new employer-provided or private retirement plan or simply taking the money outright. The important thing here is that most financial planners would agree that the latter choice is not generally a good one: In cashing out retirement funds previously earmarked as tax-advantaged, employees have to pay tax on those funds at their regular tax rate and can pay another 10% in early-withdrawal penalties.
Protocols for rollovers and retirement plan changes
Here's the thing: Companies often dump checks on departing workers by default, without appropriate instructions that clarify these choices. Although some employers will allow retirement money to be held in their own plans after an employee leaves, account holders may not be aware of this choice.
There's also a timeline for rollovers that typically applies to the money. Traditionally, individuals have 60 days to get funds from their old employer and roll them into a new IRA or 401(k). But some of these timelines can have to do with company policy as well. For instance, it can be tricky getting the actual checks from human resources or payroll departments -- and that's where workers who are moving from one job to another, or taking time off as a stay-at-home parent, have to be savvy about what happens to their retirement money and proactive about this issue upfront, rather than waiting for the default to occur.
New options for younger workers
Other recent changes in retirement rules include a new option for workers to roll over existing 401(k) funds into what are called Roth accounts. A traditional retirement fund is deposited tax-free and taxed when it is taken out -- i.e., at retirement. A Roth account involves taxes being taken out, with the remainder deposited to be grown tax-free. Although Roth accounts aren't popular with many workers because contributions seem to have big chunks taken out of them, more financial advisors are now showing why it may be a good idea to pay these taxes upfront. Look for new opportunities to use a Roth IRA to enhance your own retirement plan, whether you're attached to one employer or moving from one to another.
Yet you also have to follow the rules. Such rollovers must be done directly from the original 401(k) to the new Roth IRA in order to be done correctly. The IRS is working with employers to help them to allow these kinds of options and to extend deadlines for Roth contributions.
These types of details are key to helping career professionals grow capital for their retirement. It's pretty commonly known that there's a retirement crisis in America and that too many of us do not have sufficient funds invested to provide for ourselves in our golden years. Understanding items like the uses of a traditional or Roth IRA, and rules for converting retirement money between employers, can help an individual save up a lot more money over the course of his or her lifetime, to provide for a family's finances over the long term.
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Justin Stoltzfus is a contributor to WiserAdvisor.