Yahoo Finance Experts: What Should You Do If Your 401(k) Retirement Plan Is Terminated?
Employers don’t have to offer retirement plans such as 401(k)s or 403(b)s. They cost employers a pretty penny, and when lower revenues force hard decisions, sometimes retirement plans face the chopping block.
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For that matter, companies could go out of business entirely or declare bankruptcy. Look no further than Bed Bath & Beyond filing for bankruptcy protection in 2023, as detailed by The New York Times.
But where does that leave you and your retirement funds? What should you do if your 401(k) plan disappears in a puff of smoke?
You have a few options at your disposal.
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Option 1: Roll Funds Over to an IRA
While employer retirement plans can come and go, you fully control your individual retirement account (IRA).
“Employees can rollover the balance of the terminating 401(k) to an IRA or Roth IRA that’s held outside of work,” explained Scott Sturgeon, founder and senior wealth advisor at Oread Wealth Partners. “But if you do that, make sure you never take actual receipt of the funds as that could trigger a taxable event.”
“To avoid that, make sure the rollover is done as a direct transfer — and that you never receive funds in your checking account or get a check made out to you personally,” he said.
Your ex-401(k) administrator should offer a simple way to transfer funds to an IRA. Log in or contact your IRA brokerage service for transfer instructions.
“This option is likely best for most people as it avoids tax recognition treatment and maintains the real tax benefit of using an account like a 401(k) for investing over the long term,” Sturgeon added.
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Option 2: Roll Funds Over to a New 401(k)
If you’ve already changed jobs and your new employer offers a 401(k) or 403(b), you can roll the funds directly into the new account.
“Contact the 401(k) provider at your new job to have them assist in transferring funds over,” said Sturgeon. It’s truly that easy.
“Both an IRA and another employee sponsored plan will allow you to defer taxes on the growth,” said Sharon Hayut, managing director at Magnus Financial Group. “I generally prefer IRAs because they provide an individual with many more options for investing.”
Option 3: Take the Money and Run
You don’t have to keep the money invested in a retirement account at all. You could pocket it and go put it all on red in Atlantic City. Doing so comes with several nasty consequences, aside from the loss to your nest egg.
Sturgeon outlined how it works: “You can take an outright distribution of whatever balance you have in your 401(k). This provides immediate liquidity, but if it’s a pre-tax 401(k) you’re going to be taxed on the amount you receive.”
“If the balance is particularly large, that could push you into a higher tax bracket, forcing you to pay taxes at a higher percentage. This might make sense as a last resort for those who really need the money, but there are likely better options.”
Hayut added that the IRS comes after you for more than just the unpaid tax balance. “If you opt to take the money out before age 59½, you could pay up to a 20 percent penalty.”
Consider a Roth Conversion
Did you initially invest in a traditional 401(k) for the immediate tax deduction?
Now is a good time to reconsider whether you should invest through a Roth account instead.
As a recap, you pay full taxes on the contribution amount now — but the money compounds tax-free, and you pay no taxes on withdrawals in retirement. The further you are from retiring, the longer your money has to compound (and the more attractive this option becomes).
“Regardless of which option you choose, it can be really beneficial to meet with a fee-only financial advisor or tax professional,” Sturgeon advised. They can provide advice for minimizing your tax burden, and help you spot any costly errors.
“These professionals can help ensure you’re not missing anything that could potentially become a problem later on when tax time comes,” he said.
As a final thought, Roth IRAs offer far more flexibility than other retirement accounts. They come with flexible options for withdrawing funds penalty-free, since you’ve already paid taxes on them. If you want to invest for retirement, but worry you might need to access the money sooner, talk to a financial expert about a Roth IRA.
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