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Over the past few decades, Americans have witnessed a shift from defined benefit plans to defined contribution plans. The most notable defined contribution plan is the 401(k), many of which are forgotten about once we change jobs.
In fact, millions of Americans are leaving assets in a 401(k) after changing jobs. TIAA-CREF estimates that 30% of respondents (so likely a conservative number) say they’ve left assets in 401(k) or 403(b) plans at a previous employer. That equates to tens of millions of Americans owning “orphaned” plans.
Tax season is a good time to ask yourself if you have an orphaned 401(k) plan needing attention.
Why do we leave behind 401(k) plans? Various circumstances have exasperated the problem of orphaned 401(k)s, including
- a general lack of awareness of what to do with an employer-sponsored plan upon leaving jobs;
- a higher rate of job-switching among Millennials;
- an increase of auto-enrollment, sometimes without employees even aware they’re enrolled in a retirement plan; and
- inequality of investment options among 401(k) plans.
Let’s address the first and last bullet points above.
First, you generally have a handful of options when it comes to what to do with the plan. However, most choose between cashing out and rolling over the assets.
Cashing out your orphaned 401(k) could mean a 10% withdrawal penalty as well as income taxes on the full amount. For many, the immediate tax hit is not preferred and may set a bad precedent for how they deal with retirement funds in the future. Instead, a rollover to another 401(k) or IRA may be the better option.
However, a rollover to another 401(k) may not be a preferred option either. For starters, you may have limited investment options that might contradict with any assets held in your orphaned 401(k). Investments held in your orphaned 401(k) may not even be allowed in your new/current employer’s plan.
Or you may be delayed in having access to your new employer’s 401(k) plan. Many employer plans prohibit enrollment into a 401(k) until the new employee meets a tenure stipulation (often one year). What do you do for that year? Do you just let your orphaned 401(k) remain dormant?
As a result of these challenges, a better option may be to roll the orphaned 401(k) into an IRA.
An IRA may address each of the issues discussed above:
- a properly-performed 60-day rollover into an IRA will avoid withdrawal penalties and taxes;
- an IRA, particularly a Self-Directed IRA like those held by Kingdom Trust, will provide a wealth of investment options; and
- if you choose, you may use the IRA as a rollover vehicle to bridge the gap between investment activity in the orphaned 401(k) and any activity in a new 401(k).
There may be a waiting period with your former employer before you can address any assets in the orphaned 401(k). When you’re able to deal with the orphaned account, however, the rollover process is generally pretty painless.
Contact the investment firm managing the orphaned 401(k) and inform them you’d like to roll the account into an IRA. Some firms will allow a direct rollover, but generally they prefer to distribute the assets to the account holder so he or she will be tasked with the interaction with the new trustee or custodian.
Presuming it’s an indirect, 60-day rollover, you have a 60-day grace period before the distribution is treated as taxable income. As long as you deposit the assets into the new IRA before that period ends, you should retain the tax advantages of the account.
If you have an orphaned 401(k) and want to roll over to a Kingdom Trust account, all you’ll need to do for us is complete a Deposit Instructions form once you have the distribution. After you fund the account, you may begin to make investments in the new IRA. You will be able to take an active role in your retirement instead of having an orphaned account sit unused.