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Changing Jobs and Your 401(k)
The Wrong Move Can Cost You Thousands in Taxes, Penalties, and Forfeited Employer Matches
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Thinking of changing jobs? Be sure to consider the impact on your retirement funds when deciding whether you'll come out ahead financially. A lack of understanding or a failure to fully evaluate the consequences can cost you thousands of dollars in lost employer matches, additional taxes, and penalties.

Your Vesting Status

If you participate in a 401(k) or similar retirement plan, are you fully vested? Sometimes waiting another few months or a year can make a big difference in how much money you'll take with you. The money you contributed yourself through salary reduction contributions is always 100% vested, but your company match usually vests over a period of several years, commonly three to five. Check your plan documents or ask your human resources department when you'll be 100% vested. By changing employers before being fully vested, you'll forfeit a portion of your employer's match and any earnings on that match.

For example, let's say that under your plan's terms, you vest 20% a year for five years. You've been with your employer for a month shy of four years, so you're 60% vested. Let's say you earned $40,000 a year and contributed 15% of your salary, or $6,000 a year, to your 401(k) plan. Your employer matches 100% of your contribution, or another $6,000 a year. If you leave now, you'll receive 60% of the employer match, or $14,400 ($6,000/yr x 4 yrs = $24,000 x 60%). If you stayed another month, you'd vest an additional 20% and receive an additional $4,800 of employer match. If you stayed another 13 months, you'd receive an additional $9,600 in employer match for the four years you've already been there, plus the $6,000 match for your fifth year, for a total of $15,600 BEFORE taking any earnings on the match over the five year period into consideration. Even if your employer's match is much less than 100%, you can still see how you might be walking away from a big chunk of free money by not carefully timing your departure.

Decide What to Do With Your Money When You Change Jobs

Once you've made the decision to change jobs, the most important question facing you will be what to do with your 401(k) money. Far too many people end up cashing out their retirement savings when they change jobs, and using the money for something else. Not only do they seriously harm their future retirement, they end up giving much of the money to dear old Uncle Sam.

Let's say you have $50,000 in your 401(k) plan. Instead of setting up a direct rollover to another plan, you have the money paid directly to you. Your plan administrator will automatically take 20% out for taxes, as required by law, so you'll receive a check for $40,000. When tax time rolls around, you may be surprised to learn that if you're under age 59 1/2, you'll have to pay a 10% penalty, or in this example, another $5,000. Now your money has shrunk from $50,000 to $35,000.

The hurting doesn't stop here. You may very well be in a higher tax bracket than the 20% that your plan administrator withheld from your funds, so you'll have to come up with the difference. If you're in the 31% tax bracket, you'll have to cough up the difference between 20% and 31%--an additional 11%, or $5,500. If you haven't planned for this additional tax bite, and many people don't, you may have to borrow to come up with the additional taxes. Oh, and your original $50,000 is now down to $29,500. Now calculate your state and local taxes on the $50,000 and deduct that from the $29,500 remaining, and you're probably down another $5,000 or so, depending on where you live. Ouch!

In effect, you've walked away with only half of your original investment and have seriously shortchanged your retirement. You may have thought you'd come out ahead by changing jobs if the new job offered a higher salary, but you can see that it would have to be considerably higher to compensate for the lost "free" money you would have received by staying until you were fully vested.

What Are Your Options?

Now let's look at your other options.

Roll your 401(k) funds over into your new employer's plan--Check with your new employer to see if they offer a 401(k) plan and when you'll be eligible to participate. If there's a waiting period for participation, consider leaving your funds in your old employer's plan until you're eligible under the new plan. Make sure all rollover checks are written out directly to the new plan administrator, not to you. If the check is written directly to you, your plan administrator will deduct 20% for taxes and you'll have to come up with the 20% difference in order to do a complete rollover and avoid taxes. You'll get the 20% back when you file your income tax return at the end of the year, as long as you rollover 100% of the funds within 60 days, but why let Uncle Sam use your money interest-free?

Leave the money in your old employer's plan--If you have at least $5,000 in your 401(k) plan, most employers give you the option of leaving your funds in your old plan. As long as you're satisfied with the performance of the investments and administration of the plan, this can be a good option, especially if your new employer doesn't offer a 401(k) plan.

Roll the money into a rollover IRA--If you can't or don't want to leave your money in your old employer's plan, and your new employer doesn't offer a plan, you can go to nearly any bank or financial institution and open a rollover IRA. With a rollover IRA, you can invest your funds in virtually any stock or mutual fund.

By considering all of the implications discussed here, you can wisely evaluate the impact that changing jobs might have on your retirement savings, and make the most informed decision.

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