Understanding your employer sponsored 401k.

So, you got the new job at that company you’ve been wanting to work for. Congratulations! One of the great perks that the company offers is their employer sponsored 401k. You’re in and ready to contribute. Before you do, you might want a deeper understanding of what a 401k is or you may need to understand what happens to your previous 401k and the options you have.

What is a 401k?

A 401k is an employer-sponsored fund offered that ensures employees have dedicated retirement funds. For at traditional 401k, a specific percentage (that is chosen by the employee) is deducted from the gross pay of the employee and transferred to the 401k account.

For a Roth 401k, the amount deducted is from employees’ net pay after tax. The structure of the investment is usually bonds, a mix of mutual funds, and stock which is selected by the employee.

Did you have a 401k from your previous job? What are your options?

Rollover your existing 401k investment into your new one:

If your new employer offers a 401k then you can choose to participate in their 401k plan, and rollover your old 401k plan into your new one. With this option you will not have any penalties or taxes and it should be a smooth transfer of assets. A great tip is to be sure to review your old plan fees and performance vs. your new 401k plans to see which one is more beneficial.

Rollover your 401k to an IRA:

If your new plan has higher fees, then you can rollover your 401k plan into an IRA. This is one of the most popular options, as it streamlines your retirement savings and consolidates all of your 401k balances into a single IRA. If you’re looking for better performing funds this might be a great option to consider. Be sure to consult with your monietalk advisor about this possible option.

Convert your existing 401k to a Roth IRA:

For some people this might not be the most advisable option as there might be tax consequences that you did not plan for. If you convert your 401k pretax account into a Roth IRA, then you will first have to transfer it in a traditional IRA with a new financial institution. The reason you choose an IRA first is because the tax rules for the 2nd account are the same, because when money grows you’re not taxed, but when you start taxing distribution you will be taxed at your tax bracket at the time of the distribution. Once your funds are in the new traditional IRA then you can convert them into a Roth IRA, but before you will have to pay taxes on the entire amount.

The good thing is that the 10% early withdrawal penalty doesn’t apply to any amount that gets rolled into the Roth IRA. If you choose this option it’s considered to pay the taxes owed with money from your accounts, NOT from your 401k money, when doing the conversion.

Roth Conversion Process:

401k -> transfer ->IRA -> convert to (pay taxes) Roth IRA

*We recommend that you seek advice from your monietalk advisor when considering this option.

Consider your Roth IRA option also:

Money under a Roth IRA grows tax free, and withdrawal is not taxed either.

Lump Sum Distribution:

If you decide that cashing your old 401k is best, then you will need to keep in mind that the money cashed out of your 401k is considered earned income, so it might take you into a higher tax bracket. This is the reason why this option is not advisable, and we recommend working with a monietalk advisor for a free consultation on the other options available to you.

Conclusion

There are so many options to consider when you start a new job and need to decide what to do with your previous 401k. monietalk can help you make the best decision for your situation based on your current strengths, goals and objectives.