If you are thinking about leaving your long-time employer and wondering about whether to move your retirement savings away from their retirement plan, there are a few things to consider.
Saving into a company-sponsored retirement plan like a 401(k) or a 403(b) is a great way to pile up money for retirement. Most companies offer matching money to add to your savings. Often the formulas will be something like 4 percent of your gross pay added free if you save 5 percent of your gross pay. That’s a great return with no risk.
And if you work at a big company with your retirement plan at a major custodian like Fidelity, TIAA, Vanguard or Empower you probably have very cost-effective investments and a generally inexpensive retirement savings account. But, if you work at a smaller firm—like most Americans—with a plan that’s through Paychex, ADP, John Hancock or Principal you might be paying more for the plan and its investments than you realize.
If you are evaluating whether to leave your retirement savings with your company’s custodian or take it with you, here are some things to consider:
- What is the cost of the plan at the company? The fees and expenses must, by law, be disclosed to you, but often it’s done in a huge complex document that most folks don’t bother to read. But the information is in there. You are looking for average fund expenses, advisory fees, investment management fees and recordkeeping fees to start with.
2. Have you saved to a traditional retirement account or a Roth account? Traditional retirement plans allow you to deduct the savings contributions from your annual income. If you make $100,000 a year and save 15 percent ($15,000) into your retirement account, you would show $85,000 of taxable income for the year. The $15,000 your save, plus the matching money, plus all growth, dividends and interest accumulates in the account tax free until you spend it. Every withdrawal from this account is taxable income in the year you take it.
Roth retirement accounts allow you to save your after-tax money into a Roth account. You do not get to deduct the money. You pay income taxes on it the year you earn it. But the amount you save and all the growth, dividends and interest on that money grows tax-free and comes out tax-free when you spend it. Any matching money would be treated the same as traditional retirement savings. You do not count it as income in the year it’s added to your account. You do pay tax on all the money that comes out of that part of your retirement fund.
If you have both traditional 401(k) money and Roth 401(k) money, you may be more interested in getting out of the plan when you leave. If you do, you will set up a traditional IRA to hold the money that has income tax due when you spend it. And, you will set up a Roth IRA money for all the tax-free money you have piled up.
Once you set up the two IRAs you have the OPTION to convert some of the traditional IRA money into Roth money. You will owe income tax on the converted amounts, but often after you leave the big job, you may find that your taxes are reduced. The key is that having the money in IRA accounts give you flexibility.
3. Will your income be higher or lower in retirement? Traditionally, the assumption was that you would have noticeably reduced income in retirement, and therefore, lower income tax rates. This was a powerful argument in favor of traditional 401(k) saving. You avoid taxes now and pay a lower rate later. But today, most retirees spend as much, or more, money in the first few years of retirement as they earned in the last five years of work. If you are spending money at the same rate, it’s likely that your taxable income will be at the same level. So you will pay the same tax per $100 after retirement as before.
And if you are earning less money after leaving the big job, then you will likely dip into savings to pay the taxes on a traditional 401(k) distributions—another argument in favor of Roth IRAs.
4. Who stands to inherit your retirement money when you are gone? Company retirement plans often give heirs fewer options than self-directed IRAs. If you really want your kids, or your grandkids, to get your retirement money you will want it out of the company plan.
5. Do you plan to start Social Security early, or do you want to max out your benefit? If you start early, you will want to be very careful about any retirement plan distributions. Social Security income is taxed more for higher income taxpayers. If you take Social Security before your full retirement age (usually age 67) you could lose some benefits if you show income from a pre-tax retirement account. And, you will also likely pay more income tax on Social Security based on pre-tax retirement account income.
If you max out Social Security benefits by starting to take income at age 70, that income will begin just as you are required to remove part of your pre-tax retirement savings (beginning at age 70 ½). So you could show higher total income, more tax on social security and a higher tax rate overall.
6. Do you think tax rates could ever rise? History shows that the U.S. tax code gets changed a lot. According to eFile.com the U.S. tax code has been changed 4,000 times over the last 10 years. With record budget deficits, the odds that some income tax rates could go up over the next few years is pretty good.
If you leave your money in your company plan, or in a traditional IRA, you are at risk for any future income tax changes. Since none of that money has been taxed as income so far, any future change in the tax rules would hit your future distributions. If you have your retirement money in Roth accounts, you have already paid income tax and are shielded from any future tax changes.
Remember, if you earn money, you’ll have to pay some taxes. But you often have options about how to manage that burden. I recommend you consult with a tax advisor about how to best manage your income taxes this year and over time.
Be sure to consult with a professional who will provide advice on managing your taxes. Many tax professionals focus solely on filling out tax forms based on your information. They do not want to give you advice. If you have saved a bunch of your retirement money into the company plan, you need advice about the tax strategy.
You might also benefit from a conversation with a CERTIFIED FINANCIAL PLANNER™ professional. CFP® professionals are trained in all aspects of financial life, including taxes, and can give you holistic advice based on your entire situation.
To find a CFP® professional near you, start your search here.
As you visit with financial planners, I suggest a couple things to check:
- Is the advisor always the client’s advocate – a fiduciary advisor?
- Is the advisor only paid by clients, not any financial product manufacturer or distribution network? That would be a fee-only advisor.
These two points help assure that you are working with a professional who is committed to your best interest at all times. It seems sort of obvious to me that a professional would work in this way, but it’s not automatic.
A fiduciary, fee-only, CFP® professional can help you make great retirement income choices and develop a comprehensive financial plan that is driven by your goals and priorities and addresses all aspects of your financial life. With a big-picture approach, you will be better prepared to understand your options at every step along the way.
Yes, I am a CFP® professional. I’m always a fiduciary and I only work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice.
If this article has you thinking about your own circumstances, contact my office at email@example.com. I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.