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U.S. workers change jobs every 5½ years, on average.1 These changes often include a significant decision regarding the assets in their former employer’s 401(k) or other defined contribution plan. Unfortunately, about 45% of people cash out their balances in workplace plans when changing jobs, and the percentage rises to 55% for those with balances of $5,000 or less.2

When you take a distribution from your 401(k), you will owe ordinary income tax on the withdrawal and possibly a 10% early-withdrawal penalty if you are under age 59½. The biggest penalty, however, might be the loss of future retirement dollars. Consider that even a $5,000 401(k) balance could grow to more than $30,000 over 30 years, assuming a hypothetical 6% annual growth rate.3 Cashing out a larger balance would have greater consequences.

Careful with Your 401(k)

Preserving Tax-Deferred Money

Depending on your situation, you may have several other options for your 401(k) assets when changing jobs. All of them keep the tax-deferred status of your retirement funds and offer the potential for continued tax-deferred growth.

Keep money in former employer’s 401(k).

This could be a conveniently short period option (if allowed by your old employer), but you will not be able to make future contributions. Keep in mind that many employer plans may automatically transfer balances under $5,000 to an IRA and automatically cash out balances under $1,000.

Transfer monies to a new plan.

If your new employer offers a 401(k) or other workplace retirement plan that accepts rollovers, this strategy might make sense if you are comfortable with the fees and options in the plan and expect to stay with your new employer for some time.

Roll monies to an IRA.

IRAs typically provide a wider variety of options than employer plans and enable you to consolidate your retirement assets in a single account. Moreover, the IRA is yours to control, regardless of your employment situation.

For either type of rollover, it’s more efficient to execute a trustee-to-trustee transfer from your old plan to the new plan (or IRA), either directly or in the form of a check made out to the new trustee. If you receive a check payable to you from your former employer’s plan, 20% will be withheld for federal income taxes. You have 60 days from the date of the check to roll over the entire distribution — including the tax withheld — to an IRA or another employer-sponsored plan; otherwise, the amount not rolled over will be considered a taxable distribution.

Distributions from traditional IRAs and most employer-sponsored retirement plans are taxable as ordinary income. Withdrawals before age 59½ may be subject to a 10% federal income tax penalty, with some exceptions.

1) Employee Benefit Research Institute, 2015
2) InvestmentNews, February 17, 2015
3) This hypothetical example of mathematical principles is used for illustrative purposes only and does not represent the activity of any particular financial instrument. Fees and expenses are not part of the calculation, and they may reduce the activity or increases described. Actual results will vary.

Freeman Owen, Jr -Retirement Specialist

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