In the wake of the COVID crisis, millions of Americans are suddenly facing a job change. Since early March, more than 40 million workers have experienced some form of temporary or permanent job interruption, according to the U.S. Department of Labor.
While a job loss is usually never welcome, it can be a pivotal time to reassess your path and seek an upgrade to your career, your goals, and your financial life. If you happen to have been recently impacted by a job change, you know how daunting this can be.
“Because retirement savings can fall into the category of “set it and forget it”, many savers don’t understand the complex issues at hand when taking action on their 401(k) savings.”
One of the many decisions you face is how to handle your 401(k) savings with your former employer. Because retirement savings can fall into the category of “set it and forget it”, many savers don’t understand the complex issues at hand when taking action on their 401(k) savings.
So, in the spirit of avoiding faulty decisions, here are four costly mistakes savers should avoid when taking action on their 401(k).
Mistake #1: Cashing Out
Unfortunately, too many Americans cash out their savings when they change jobs, especially when they perceive their balance to be relatively small. When they do, costly mistakes happen on two fronts.
Secondly, those who cash in their 401(k) balances miss out on the power of compounding interest over their remaining working years. What may seem small today can be really material down the road. With just a seven percent investment return, balances today can grow to more than seven times larger over 30 years. In other terms, a $40,000 balance today can grow to more than $300,000 with those assumptions.
First, taxes take a bigger bite of the withdrawal. Not only are funds subject to ordinary income tax, but there is an additional tax penalty when using funds prior to retirement age.
Mistake #2: Mis-handling After-Tax Contributions
Often overlooked is the fact that many employer retirement plans offered “after-tax” savings options. These options allowed employees a different way to save beyond their usual “pre-tax” contributions.
Having “after-tax” savings creates an attractive opportunity to roll the funds into a Roth IRA. The major benefit of the Roth IRA is that any future investment growth can be withdrawn tax free after retirement age.
For some, this benefit can save investors thousands in taxes. However, mistakenly rolling over those same funds into a traditional IRA can subject the investment growth to being taxed. Furthermore, years down the road, the saver may face an unnecessary recordkeeping burden to prove up the source of their after tax IRA to the IRS.
Mistake #3: Mis-handling Highly Appreciated Company Stock
While company stock inside a 401(k) plan isn’t as popular as it once was, there are still many companies that do offer it. In some unique situations where the stock balance has been built up over many years, a simple rollover to an IRA can be a costly mistake.
For investors who have a low cost basis, it may be more advantageous to take the common stock shares out in kind. The investor will pay income tax on the cost basis in the year of the transfer. The trade off, though, is the unrealized appreciation can be taxed at a lower capital gains rate when the stock is sold at a later date.
Mistake #4: Neglecting the Account in the Former Employer’s Plan
Too often, not knowing how to move means individuals simply leave their savings behind with the plans at the previous employer. Without greater scrutiny, this can be unwise. Many 401(k) plans still have expensive fees. Others have limited fund choices, leaving out useful asset classes. Even more, oversight committees can be very slow to replace underperforming funds.
“For investors who’ve put away savings in the company retirement plans, realize you’ve done the hard work. But, sometimes it takes expertise to keep it on track.”
“In general, 401(k) plans have made considerable progress with fees since 2012, but there are still a lot plans that are way too expensive,” said CFP Christopher Riggs, who has consulted with both mega-sized and small 401(k) plans since 1997.
“Furthermore, oversight committees have to balance the need for simplicity within their offered plans. That frequently means leaving out needed asset classes for certain economic conditions.”
For investors who’ve put away savings in the company retirement plan, realize you’ve done the hard work. But, sometimes it takes knowledge or experience to keep it on track. So, what to do if you don’t have to time to become a professional? Talk to one.
“A strong retirement is often the result of several sound, but seemingly small, decisions. It is important for investors to get help when complexities go beyond their comfort zone.” added Dean Harman, founder of Harman Wealth Management.
At Harman, we are independent fiduciaries that focus on retirement planning with your best interests in mind. You get an experienced set of eyes on your situation, including a retirement milestone analysis and big picture meeting on your retirement goals. Contact a financial professional at Harman Wealth Management for professional advice and consultation.