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Effects of Changing Jobs on 401 (k) Plans

If you have come to the point of considering changing your current employer, you should carefully consider what impact will have this job change on your 401 (k) plan. Since such things as penalties, taxes and employer matches are included, you should cautiously study the effects of these on your plan.

Vesting Considerations

The first thing you should consider when deciding to change your job is your vesting status. Since money accumulates the more time you spend within the current employer 401 (k) plans, it might be a good idea to not remove your plan for several months. Generally, 100% vesting is provided for the contributions you make out of your monthly salary. Nevertheless, if your employer provides matching of your contributions, this matching vests for a particular time period (three to five years). You should refer to your 401 (k) plan documents and ask the responsible people in the company to see when exactly you will be provided with a 100% vesting. Otherwise, you may end up losing your rights in terms of employer matching and the corresponding profits.

Consider the following example in order to better understand the impact of being fully vested. Tom has decided to be 25% vested per year, which will continue over a four-year period. Tom's annual salary is $60,000 and he has estimated that he can spare 12% out of his income for annual contributions. As a result he allocates $7,200 every year for his 401 (k) plan. We assume that his employer matches 100% of this amount. Tom has been with his employer for 2 years and 10 months but for some reason he wants to change his job. Since less than 3 years have passed Tom is 50% vested. If he decides to change his job now, he will receive 50% of the employer's match. This means that he will get 50% of the $21,600 ($7,200 x 3 years), which amounts to $10,800. If he changes his mind and decides not to leave his job for at least two more months, Tom will increase his earnings with additional 25% meaning he will get additional 5,400$ of employer match. Likewise, if Tom decided to stay the whole four-year period with his employer, he would get additional $18,000 of the employer's match.

The moral of the example is that you should carefully plan on the time of departure of your job, since you may lose money from the premature leave.

Received Money Plan

Now that you have firmly decided to leave your current job, you should not only consider the way you will find another, but also construct a plan on what you are going to do with the money of your 401 (k) plan. You should avoid committing the common mistake of spending the money on something and not reinvesting them and ensure your retirement years and tax avoidance.

Consider the following example. John has $60,000 in his 401 (k) plan. He has decided to change his job, but has not required for an automatic rollover to the retirement plan of his new employer. As a result, he is given the money on hand and under the law requirements he faces a 20% tax. Thus, he ends up with $48,000 in his account. Unfortunately, John is 52 years old and being under the age of 59 ½ he has to pay a 10% penalty or additional $6,000 out of his pocket. As a result he has $42,000 left to reinvest from his initial $60,000.

Depending on the tax bracket in which John is, he will have to pay the difference if he is in a higher one. For example, if John is in the 26% tax bracket, he will have to pay additional 6% or $3,600. This further decreases his money to $35,400. John is also liable to state and local taxes, which depending on the state in which he lives may deprive him from a few thousand dollars more. As you can see, John's money disappeared almost by half.

As a result of all these required by law deductions, John has seriously reduced his initial investment and the corresponding money he can put in his new 401 (k) plan. Even though John has found a better paying job, it will be hard to compensate for the lost money.

Potential Alternatives

Now, we would like to present to your attention several alternatives you have about your 401 (k) money received after quitting your job.

  1. Don't take the money with you.

    Many employees will offer you to leave your 401 (k) money with the company's retirement plan. This is offered in case you have no less than $5,000 in your retirement account. You should consider this option if your new employer doesn't offer a 401 (k) possibility. Additionally, if you are pleased with the management of the 401 (k) investments and they give you good returns, consider the option of leaving your plan with the company.

  2. Reinvest your money into the new employer's 401 (k) plan.

    If your new employer offers a 401 (k) plan, don't hesitate to roll the funds from your previous one to the new one. Before this you should check the eligibility rules and whether there is a required waiting period. If the latter is true, ask your previous employer whether you can leave the money with the company until this period passes. In order to avoid the 20% taxes, you should require the checks to be directly written to the new 401 (k) plan administrator. Otherwise, you will have to pay the difference of 20% in order to make a complete rollover with its tax implications. This 20% will be given back to you at the end of the tax year, but you will have to meet different requirements.

  3. Rollover IRA Investment

    You should consider the option of opening a rollover IRA account if your future employer doesn't provide a 401 (k) plan. Additionally, this option is suitable if your past employer doesn't give you the opportunity to leave your money with their retirement plan. Rollover IRA accounts are widely available through many banks and directly invest your money in a mutual fund or stocks.

Having all these facts in mind, you should be very cautious the next time you decide on changing your job, due to the effects it may have on your 401 (k) plan. Take under consideration the options we have provided and carefully think over the right time of changing your job in order not to lose any of your money.

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