Handling Your First Retirement Plan Distribution When Changing Jobs

If you have participated in a company retirement plan like a 401(k) and change jobs, you will probably receive a distribution of the funds you’ve accumulated in your plan. The distributions are often called lump sum distributions. If you’ve participated for several years, the distribution could be quite substantial. Over your working career, you may receive several lump sum distributions, and what you do with those funds and how you handle the distribution is important.

While you might be tempted to just take the money and spend it, remember that there could be income taxes and likely an extra tax penalty. After all, the funds are for your retirement. By resisting that temptation, you have the chance to grow your wealth and take a significant step toward a financially secure retirement.

Reviewing Your Options for a Retirement Plan Distribution

Before you officially leave the company, you will probably meet with someone from your Human Resources department to finalize the details of your termination. This will probably include discussing a final paycheck, determining any unused vacation or sick days, and your options for taking a distribution of your retirement plan account. It can take 30 to 90 days to finalize the distribution, but you will need to make decisions at that time and upon receipt of the distribution check.

1. Do you want to pay tax on the distribution now or have it remain tax-deferred?
2. Do you want to leave your funds with your prior employer’s plan, move them to your new employer’s plan, or transfer them to an IRA?
3. How do you want the money invested?

If you have been a participant in a plan for a long time and have accumulated a large sum of money, these decisions can have a very large impact on your financial future and that of your family. Considering the decisions carefully is critical. Be sure you fully understand your options and get professional help if you need it.

Pay taxes or not

While your funds were in the qualified plan, any earnings were tax deferred. When you receive the distribution, you have 60 days to roll over your funds to your new employer’s plan (if allowed) or into an Individual Retirement Account. If you don’t act within 60 days, your distribution will be subject to regular income taxes and an additional 10% early withdrawal penalty if you are under age 59½.

Unless you absolutely need the money right away, it is usually best to keep the tax deferral status. When you receive the distribution check and plan to transfer it into an IRA or your new employer’s plan, do so quickly. If you don’t deposit it within 60 days, you will owe taxes on it and face a 10% penalty.

Where to keep your funds

To keep tax deferral, the funds must stay in some type of qualified retirement account. Many retirement plans allow you to leave funds in the plan after ending employment. You might also be able to transfer the distribution to a new employer’s plan. The third option is to move the funds to an IRA.

The choice of where to invest your money should depend on how much control you want. An IRA likely offers the most flexibility, but it also requires you to make more decisions. You should also consider the costs of administration and asset management fees.

Even if you’re uncertain about your long-term plans, you might consider transferring the funds into an IRA. You can always make withdrawals later if you decide to.

Investing your funds

Your retirement plan distribution may be the largest single sum of money you have received. The investment of those funds should be handled very carefully. Be sure to consider how these funds fit into your overall financial planning efforts.

Be sure to consider your time horizon and risk tolerance when making investment decisions. If you transfer your distribution to your new employer’s retirement plan, evaluate the investment options and select appropriately. If you choose the self-directed IRA route, most institutions offer accounts that allow you to select stocks, bonds, mutual funds, money market funds, and other investments.

Don’t feel pressured to make all investment decisions right away. As long as the funds stay within another qualified plan or IRA, you won’t owe taxes, and you can take your time to make informed and careful choices.

Conclusion

Receiving a lump sum distribution is a major financial event. The choices you make will affect your financial security for years to come. Be sure to evaluate all your options, seek guidance as needed, and make a wise decision. Your future financial security depends on it.