Layoffs are a fact of corporate life as companies cope with economic cycles and global competition. If you get caught in a corporate downsizing and you are not immediately moving to a new employer, you commonly have three options for your retirement plan assets:
- Leave your money in the current plan.
- Take a cash or “lump sum” distribution.
- Transfer the money to another qualified retirement account such as an individual retirement account (IRA).
Consider the merits of each option.
Option #1: Stay Put
You may be able to leave your savings in your existing plan if your account balance is more than $5,000. By doing so, you’ll continue to enjoy tax-deferred or tax-free compounding potential and receive regular account statements and performance reports. Although you will no longer be able to contribute to the plan, you will still have control over how your money is invested among the plan’s investment options.
Option #2: Cash Out
You may elect to have your money given to you in one lump sum or in installments over a set number of years. A lump-sum approach has a few drawbacks, including a 20% withholding on the pre-tax contributions and the earnings portion of the qualified rollover distribution (to help cover your ordinary income tax liability) and a 10% additional tax on early withdrawals if you separate from service before age 59½ (55 in certain circumstances). Contingent on your tax bracket and state of residence, you may be liable for additional taxes and penalties. An installment approach, in which distributions are made in substantially equal payments over the participant’s or the participants and spouse’s life expectancy may not be subject to additional taxes. But this is a complex option that typically needs the assistance of a financial advisor.
Option #3: Roll Over
You are able to transfer your retirement plan money into another qualified account, such as an IRA, using a “direct rollover” or an “indirect rollover.” Note that traditional plan balances can only be rolled into traditional IRAs and new Roth-style plan balances can only be rolled into Roth IRAs. With a direct rollover, the money goes directly from your former employer’s retirement plan to your IRA without you ever touching it.
The benefits of a direct rollover include simplicity & continued tax deferral on the full amount of your plan savings. IRAs may also afford additional investment choices than many employer-sponsored plans. In an indirect rollover, you take a cash distribution, less 20% withholding, but must redeposit your qualified plan assets into an IRA within 60 days of withdrawal to avoid paying taxes and penalties. With this method, however, you’d have to make up the 20% withholding out of your own pocket when you invest the money in the new IRA, or else the withheld amount would be considered a distribution, so ordinary income tax and the 10% additional tax would apply. And in either case, an IRA may be subject to higher fees and expenses than the employer-sponsored plan it substituted.
Consider Other Short-Term Funding Sources
During times of economic hardship, it may be alluring to take money intended for future needs and use it to supplement a temporary income shortfall. But remember that any funds you take out today will ultimately reduce your retirement nest egg tomorrow. Before choosing a cash distribution from a retirement plan, consider other potential sources to meet your current income needs. For example, savings accounts and money market accounts are easily liquidated. With short-term interest rates at historically low levels, the opportunity cost for using these funds is relatively low.
If your company is in the middle of downsizing or you have been laid off, call us now for a free financial physical where a Wealthnest CERTIFIED FINANCIAL PLANNER® can review your options and guide you to an effective financial path during this time. You can reach us at www.wealthnest.com or call our office 480-699-5275.