Posted by Jorge Guerrero, CPA
We live in an ever-changing world. Some areas which will most likely change many times during your lifetime include your car, job, the place where you live, your hobbies, your relationships with others, and even the organizations you associate with. According to the U.S. Bureau of Labor Statistics, a typical person will have 11 to 12 jobs in his or her lifetime. In other words, it is not uncommon for a person to change jobs every three to five years! When you consider the U.S. Census Bureau reported 11.2 percent of our population changed their addresses in 2016, it’s no wonder things like retirement accounts fall through the cracks and are forgotten about.
In today’s world, companies often offer a variety of benefits to attract talent. These benefits usually include some type of retirement savings plan that like everything else, have terms that vary from company to company. For example, Company A may require six months of service to enter their plan while matching three percent of contributions but Company B may only require three months of service but match two percent of contributions. As a general rule, saving for retirement is always a good idea and leaving “free money” in the form of matching contributions on the table is always a bad idea. Therefore, it is a great idea to participate in your employer’s retirement plan but this is especially true when matching contributions are part of the plan.
The question remains, what happens to your money in the plan when you leave your employer to accept a position elsewhere? Are you able to keep your money in their plan or do you need to move it? What happens if you must move it but don’t within a specified time? Is there a vesting requirement on the employer’s contributions? Questions like these show just how important it is to read the plan document when you go to make “the jump” because not doing so could be costly.
Many plans require employees to take their money with them within a given period of time if their balance is less than a certain amount. In this case, failure to transfer your balance to another retirement account could result in an unexpected check in the mail for your vested account balance less withholding taxes followed by a Form 1099-R “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.” sent in January. This can be a very expensive mistake, especially since the IRS imposes a 10% penalty on distributions from “pre-tax” retirement accounts in addition to the normal income tax when you file your tax return. Roth accounts (post-tax retirement accounts) will face a penalty on the income portion of the distribution but not the contributions made. The penalty does not apply to individuals age 59½ or older by the end of the tax year. The penalty may also be avoided if the entire GROSS amount (not the amount received net of taxes) is deposited into an IRA within 60 days of the distribution. You would receive a refund of the tax originally withheld when the tax return is filed.
What further complicates the matter is a person who changes his or her address every three to five years. In this case, leaving your retirement account in a former employer’s plan may not be best idea. After a few job changes and moves over a 10 to 15-year period, will you even remember that you have the account? Will you remember to keep your address up to date with the former plan? If your new employer allows for transfers into their plan, this may be your best option. Another option is to roll the money into an IRA (or ROTH IRA if the account contained after-tax contributions). This can be done through your local bank, credit union, or brokerage. Rolling your money over into another retirement plan or IRA will result in you receiving a 1099-R in January but will not result in additional tax or penalties. One of the additional benefits of rolling the money over to the new employer’s plan or an IRA is the potential savings on fees you were paying to the old plan.
The contributions you personally make to any retirement plan are by law always 100% vested and cannot be forfeited. If however, the plan has a vesting requirement on employer contributions, not meeting the service requirements means loss of part or all of the employer’s contributions to your account. Many companies have a graduated vesting requirement of up to six years. For example, Company A has a graduated vesting requirement where the employee receives 20% vesting per year starting at year two and achieves full 100% vesting at their sixth anniversary. In this case, changing jobs after 3½ years could result in forfeiting 60% of the contributions that your employer made to your account. For some, this forfeiture could be expensive, but at least it does not trigger a taxable event.
In conclusion, when changing jobs, make sure you know what is going to happen to your retirement account. READ THE PLAN DOCUMENTS! If permitted by your new employer, consider moving your money to your new employer’s plan; if not, roll it over to an IRA. This will keep your retirement funds together and easier to manage…especially if you move every few years.
If you have any questions about how to avoid paying unnecessary taxes on your retirement plan rollover, please consult one of our tax professionals.