"How Do I Get My 401(k) From an Old Job?"
In this episode of the Money Rehab podcast by Nicole Lapin, the focus is on managing your 401(k) when changing jobs. Lapin provides guidance on the best way to handle 401(k) balances, whether under or over $5,000, emphasizing the importance of direct rollovers to avoid early withdrawal penalties and taxes.
She warns about the costly consequences of dipping into a 401(k) before retirement age and stresses the need to proactively plan for income changes. Lapin advises exploring eligibility for valuable tax credits during periods of reduced earnings. The episode aims to help listeners navigate the complexities of preserving their hard-earned retirement savings while maximizing financial benefits amid life's transitions.
This is a preview of the Shortform summary of the Aug 14, 2024 episode of the Money Rehab with Nicole Lapin
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1-Page Summary
Managing a 401(k) When Changing Jobs
For 401(k) balances under $5,000, financial expert Nicole Lapin advises doing a direct rollover into a new employer's 401(k) or a rollover IRA to avoid taxes and penalties.
With over $5,000, Lapin recommends rolling over to consolidate accounts and simplify management. Direct rollovers are crucial to prevent withdrawal penalties.
Avoiding Early Withdrawal Penalties
Lapin warns against early 401(k) withdrawals before retirement age due to the 20% tax and 10% penalty. Hardship exemptions may waive the 10% penalty in dire situations but not the tax.
Optimizing During Income Changes
When experiencing income reductions, Lapin emphasizes reviewing tax credit eligibility, such as for the Earned Income Tax Credit if earnings dip below $59,000 annually. Proactive financial planning is key to maximize available benefits during income shifts.
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Counterarguments
- While direct rollovers can avoid taxes and penalties, they may not always be the best option if the new employer's 401(k) plan has higher fees or poorer investment choices compared to an IRA or the previous employer's plan.
- Consolidating accounts for balances over $5,000 can simplify management, but it might also limit investment options or expose one to higher fees if the new plan is not as favorable.
- Direct rollovers are indeed crucial to prevent withdrawal penalties, but it's important to ensure that the rollover is done correctly and within the IRS's specified timeframe to avoid unintended taxes and penalties.
- While early 401(k) withdrawals are generally not advisable due to taxes and penalties, there may be situations where an early withdrawal is financially strategic or necessary, and the individual should weigh the immediate need against the long-term cost.
- Hardship exemptions can waive the 10% penalty, but individuals should carefully consider the long-term impact on retirement savings and explore all other financial options before taking an early withdrawal.
- Reviewing tax credit eligibility during income reductions is sound advice, but it's also important to consider other tax planning strategies that may be more beneficial depending on the individual's complete financial situation.
- Proactive financial planning is indeed key during income shifts, but it should also be flexible and adaptable to changing laws, economic conditions, and personal circumstances.
Actionables
- Create a personalized rollover checklist to ensure you don't miss any steps when transferring your 401(k) funds. Start by listing the documents you'll need, the contact information for both your current and new plan administrators, and a step-by-step timeline for completing the rollover. This can help you avoid mistakes that might lead to penalties or taxes.
- Set up a financial calendar alert for income changes to reassess tax credit eligibility. Use a digital calendar to remind you to check your eligibility for tax credits like the Earned Income Tax Credit whenever you experience a significant change in income. This can help you stay on top of potential savings during income fluctuations.
- Designate a 'financial change' savings account to prepare for potential penalties or taxes due to unforeseen withdrawals. Open a separate savings account where you deposit a small amount of money regularly, earmarked for any unexpected financial situations that might lead to early 401(k) withdrawals. This fund can act as a buffer to minimize the impact of penalties and taxes on your finances.
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Managing a 401(k) when changing jobs
When you change jobs, managing your 401(k) is a key financial step you'll need to navigate carefully to ensure your retirement savings continue to grow without unnecessary penalties or tax issues.
If the 401(k) balance is under $5,000
Your former employer will close your account and issue a check for the balance if you have $5,000 or less in your 401(k), but this comes with taxes and penalties.
To avoid penalties and taxes
To evade the unwanted taxes and penalties that come with a cashed-out 401(k), you should execute a direct rollover of your 401(k) balance into a new employer's 401(k) plan or a rollover IRA. This ensures the funds maintain their tax-advantaged status.
If the 401(k) balance is over $5,000
For balances exceeding $5,000, you're offered more flexibility. You can opt to leave the money in your former employer's plan, although this might come with extra fees and you'll be unable to make new contributions.
Rolling over the 401(k)
However, rolling over the 401(k) to a new employer's plan or to a rollover IRA is recommended, a ...
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Counterarguments
- While a direct rollover is generally a good strategy to avoid taxes and penalties, it may not always be the best option for everyone. Some individuals may benefit from different strategies depending on their specific financial situation, tax bracket, or investment goals.
- Leaving money in a former employer's plan could be beneficial if the plan has particularly good investment options or low fees compared to other available choices.
- Rolling over a 401(k) into an IRA could limit the ability to take loans from the plan, which some employer 401(k) plans allow but IRAs do not.
- Consolidating retirement savings into one account can simplify management, but it could also lead to a lack of diversification in terms of plan providers and investment options.
- Some individuals may prefer to cash out a small 401(k) balance despite penalties and taxes if they have immediate financial needs or debts with higher interest rates than the potential growth of the retirement account.
- The recommendation to always execute a direct rollover does not consider the potential benefits of an indirect rollover, such as having access to the funds for a sh ...
Actionables
- You can set calendar reminders to initiate a rollover process for any old 401(k) accounts as soon as you leave a job. This will help you avoid forgetting about the account and facing automatic cash-outs or penalties. For example, set a reminder for one week after your last day to contact your 401(k) administrator and another reminder a week later to follow up on the rollover process.
- Create a personalized checklist for evaluating new retirement account options when considering a rollover. Include factors like investment choices, fees, and customer service. Use this checklist to compare your old 401(k) with potential new IRAs or your new employer's plan, ensuring you make an informed decision that aligns with your financial goals.
- Develop ...
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Avoiding penalties and taxes when accessing retirement funds early
Financial expert Nicole Lapin emphasizes that withdrawing funds early from a 401(k) entails significant financial repercussions and should be a measure of last resort.
Early Withdrawal Penalties
Withdrawing from a 401(k) prior to reaching retirement age comes with hefty financial consequences, including a 20% tax payment and a 10% penalty.
Hardship Exemption
Lapin points out that in certain dire circumstances, the 10% early withdrawal penalty can be waived if one qualifies for a hardship exemption. Qualifying situations might include medical conditions that necessitate leaving a job, thereby depleting the necessary funds for care and treatment. However, even with a hardship exemp ...
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Avoiding penalties and taxes when accessing retirement funds early
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Clarifications
- A hardship exemption allows for the waiver of the 10% early withdrawal penalty from a retirement account in specific dire situations, such as medical emergencies. This exemption does not eliminate the 20% tax on the distribution. It is granted based on qualifying circumstances that demonstrate a genuine need for accessing the funds early. Hardship exemptions are intended to provide relief for individuals facing significant financial challenges.
- A 401(k) is a retirement savings plan sponsored by an employer. Withdrawing funds early from a 401(k) before reaching retirement age can lead to penalties and taxes. These penalties typically include a 20% tax payment and a 10% penalty on the withdrawn amount. Hardship exemptions may waive the 10% penalty in specific dire situations, but taxes on the distribution still apply.
- When you withdraw funds early from a 401(k), you typically face a 20% tax payment on the amount you take out. Additionally, there is a 10% penalty imposed as a deterrent for accessing the funds before retirement age. These financial consequences are designed to discourage early withdrawals and ensure that ret ...
Counterarguments
- While early withdrawal penalties are designed to discourage premature depletion of retirement funds, they can also disproportionately affect individuals facing unexpected financial hardships who may not have other resources to draw upon.
- The 20% tax payment on early withdrawals is not an additional tax but rather withholding for federal income taxes that would be due on the distribution; the actual tax rate could be higher or lower depending on the individual's total income and tax situation.
- Hardship exemptions, while helpful, may not cover all types of financial emergencies, leaving some individuals without relief from the 10% penalty even in severe circumstances.
- The advice to avoid tapping into a 401(k) early does not account for the diverse financial situations individuals may face, and for some, the benefits of accessing these funds may outweigh the penalties, especially if it prevents more severe financial outcomes like foreclosure or bankruptcy.
- The focus on penalties and taxes may overshadow the potential benefits of certain early withdrawal strategies, such as the Rule of 55 or taking substantially equal periodic payments (SEPPs), which can allow for penalty-free access to funds under specif ...
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Financial planning and tax considerations during income changes
Experiencing income changes, especially when shifting from employment to unemployment, calls for meticulous financial planning and an informed approach to tax considerations. Lapin points out that understanding tax credits is essential in these situations.
Review Tax Credit Eligibility During Income Reductions
Maximizing Benefits During Income Changes
When leaving a job, it's crucial to review tax credit eligibility, as reduced income may qualify an individual for credits not previously accessible. Lapin mentions that being without income for a few months could make someone eligible for certain tax benefits, such as the Earned Income Tax Credit (EITC). For example, if an individual makes less than $59,000 in a year, they might qualify for the EITC.
Careful examination of tax credit options can significantly help to mitigate financial challenges during periods of unemployment or reduced earnings. It's therefore advised to review tax credit eligibility diligently wh ...
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Financial planning and tax considerations during income changes
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Counterarguments
- While understanding tax credits is essential, relying solely on tax credits may not be a sustainable long-term strategy for financial stability.
- Reviewing tax credit eligibility is important, but it should be part of a broader financial assessment that includes expenses, debt, and emergency savings.
- Qualifying for tax credits like the EITC is beneficial, but the process can be complex, and individuals may need professional advice to navigate the system effectively.
- The threshold for the EITC and other tax benefits may change annually, so the $59,000 figure may not be accurate for every tax year.
- Careful examination of tax credit options is helpful, but it should not overshadow the need for comprehensive financial planning that includes income diversification and skill development for future employment opportunities.
- Diligently reviewing tax credit eligibility is advised, but individuals should also be aware of the potential for audits and the importance of accurate reporting to avoid legal issues.
- Proactive financial planning is key, but it may not be ...
Actionables
- Create a tax credit checklist to track changes in your income and potential eligibility. Start by listing all known tax credits and their eligibility requirements. As your income fluctuates, update the checklist to see which credits you may now qualify for. For example, if you've had a reduction in income, check if this places you within the threshold for the EITC or other credits and note this on your checklist.
- Set up a monthly finance review day to assess your financial situation and tax credit opportunities. On a chosen day each month, sit down with your financial records and analyze your income, expenses, and any changes that could affect your tax situation. Use this time to research new tax credits or savings strategies that may have become relevant due to your income change.
- Use a budgeting ...
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