Transfer Retirement Savings When You Change Jobs

By Lisa Smith AAA

When workers change jobs, their savings in employer-sponsored plans (employer plans) tend to get withdrawn and spent. It's an understandable phenomenon, albeit an unfortunate one. We'll show you how to avoid the trap of cashing in your retirement savings, and how to transfer your funds when you change jobs.

There are a couple of reasons why people spend their retirement savings. First, there is often a lag between the time an individual who changes jobs receives the last check from his or her previous employer and the first check from the new employer. Second, many individuals take time off between jobs. If these individuals do not have enough of an emergency fund saved, they tend to use their retirement savings to pay bills until the first check from the new job arrives. Third, when the opportunity arises to spend a nice chunk of change, many individuals just can't resist the urge. Fourth, making arrangements to move and reinvest your money can be a hassle, particularly if you are not familiar with or comfortable with the idea of making investment decisions.

Unfortunately, the failure to roll over retirement assets into a new employer's plan or into an individual retirement account (IRA) is generally a big mistake that leads to bigger problems . Transferring your retirement account balance to an IRA or your new employer's plan will help to prevent you from spending your nest egg. (To learn how to transfer your retirement funds, see Common IRA Rollover Mistakes and our 401(k) and Qualified Plans tutorial.)

The Statistics Tell the Story
Nearly half of all workers in the United States take the money out their retirement plans and spend it when they change jobs, according to a 2004 Federal Reserve Board Survey of Consumer Finances. In short, many people completely deplete their retirement savings when they change jobs. Hard data on job changes is elusive, but many surveys suggests that the average worker will change careers seven times during the course of a lifetime.

Don't Make the Time Crunch a Crisis
The high percentage of cash outs versus rollovers has prompted lawmakers to take action in an effort to encourage workers to roll over their qualified plan balances to an IRA or other eligible retirement plan when changing jobs. Prior to March 28, 2005, employers could automatically close qualified plan accounts and send a check to an ex-employee if the former employee's qualified plan balance was $5,000 or less. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) changed those rules, making it mandatory for employers to automatically send plan balances to an IRA if the account balance is between $1,000 and $5,000 - unless the employee provides written permission to have the amount paid to him or her. While this is a good start, it doesn't solve the problem, as the rollovers are typically sent to money market accounts, which provide little opportunity for growth.

Why You Shouldn't Cash Out and Spend
Spending your retirement savings on anything other than retirement is a bad idea. Once that money is gone, it is no longer available to accrue earnings on your nest egg. The lost opportunity for growth through compounding can never be recaptured and can be particularly damaging for older workers with little time to replenish their nest egg. It is also damaging for younger workers that are decades from retiring. By spending $5,000 today, a worker with 40 years to go before retirement could be passing up $80,000 (assuming the spent money would have doubled every eight years) in retirement money. (To read more, see Delay In Saving Raises Payments Later On and Eight Reasons To Never Borrow From Your 401(k).)

Regardless of whether you have worked for five years or for 15 years, spending the money from your retirement plan rather than rolling it over leaves you with nothing in the way of retirement savings to show for all those years that you worked. When you start your new job, you'll be starting from scratch in the nest egg department. To help make up for the money that you spent, it is likely that any raise that you received for changing jobs will need to be invested in your new retirement plan if you want to have any hope of replacing your lost retirement savings.

If the thought of a comfortable, well-funded retirement isn't enough to keep you from spending your retirement savings, perhaps the prospect of losing money to taxes and penalties will convince you to reconsider. Consider that rollover-eligible distributions from your qualified plan account that are paid to you will be subject to a federal withholding tax of 20%; in addition, the amount may be subject to an early distribution penalty of 10% if the withdrawal occurs before you reach age 59.5 and unless you qualify for an exception.

Rollovers and Withholding Tax
When you change jobs, you usually are eligible to roll over your qualified plan balance to a traditional IRA or another employer-sponsored plan, assuming the amount is rollover eligible. If this is done as a direct rollover, no taxes will be withheld from the amount. If you have the amount paid to you instead, 20% will be withheld for federal taxes and you will have 60 days to roll over the amount. Further, if you intend to roll over the entire amount, you will need to make up the 20% withheld for taxes out of pocket.

Protect Your Future
Ideally, changing jobs should result in a salary increase and better opportunities for professional advancement. If that's the case, allocate a portion of your raise toward improving your standard of living and another portion to your retirement nest egg. Also, add some to an emergency fund, which can help to tide you over during periods when you have lower or no income. This will help to prevent you from tapping into your retirement savings at a later date. Regardless of why you change jobs, the responsibility of safeguarding your retirement savings is in your hands. Make the most of it, and take your money with you every time you change jobs.

To continue reading on transferring plan funds, see Moving Your Plan Assets?, Moving Plan Assets: How To Avoid Mistakes and Keeping Track Of Your Assets.

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