The Great Resignation: What do I do with my retirement plan?

When roughly 47 million people left their jobs in 2021, "the Great Resignation" phrase was coined. But rather than jumping ship from work itself, most of these employees were applying for better jobs with organizations that offered higher pay, greater flexibility, and better benefits.

It's important to consider perks such as retirement contributions — things like 401(k)s, 403(b)s, and Thrift Savings Plans, or TSPs — when you're weighing the pros and cons of a new job.

These are also important considerations when you're leaving the old one. When you leave an employer, whether it's your choice or theirs, you face the decision of what to do with the funds in your employer retirement plan. Regardless of the plan you have, the decisions are similar.

Read on to learn the options that might be available to you and the steps you should take to preserve your financial security during the transition.

Step 1: Keep your eye on the prize.

This part may seem obvious, but it's important: Don't forget the purpose of your account. Funds you've placed in the employer retirement plan are for retirement. Unless a higher priority exists, keep it for that purpose.

If you don't have any other income and you've exhausted all your savings, your retirement money may be the only resource to satisfy basic needs. Sometimes, life is difficult and you do what you must do. However, since these funds are earmarked for retirement, that decision can come with some negative consequences.

Step 2: Understand your options.

When it comes to a former employer's retirement plan, you have a few options. You can withdraw the money, but also can probably leave it where it is or roll it into a new account.

Let's dive a little deeper into each option.

Option 1: Withdraw the money.

If you take money out of your retirement plan prematurely, you can incur consequences. "Prematurely" is defined as younger than 59½, unless the withdrawal qualifies for an exception. Examples of exceptions include:

• Total and permanent disability of the account owner.
• Certain distributions to qualified military reservists called to active duty.
• Employees who separate from, during, or after age 55 or at age 50 for certain other reasons.

Note that qualified plans, such as 401(k)s and TSPs, have different exception rules than IRAs. While there may be some overlap, there are also some differences. Be sure to review the rules before you make a withdrawal decision.

If you withdraw money before age 59½ without a qualifying exception, the account holder must pay a 10% early withdrawal penalty, plus any taxes that are due. Why the 10% penalty? The U.S. government provides tax advantages for retirement plans to encourage people to save for retirement.

Just as they provide tax advantages, they also limit its use as you approach retirement. The amount of taxes depends on whether the account is Roth or Traditional and the types of contributions. To learn more, check out our article on Roth vs. Traditional IRAs.

To gain a full understanding of the potential tax and penalty bill, it's best to speak to a qualified tax professional.

Option 2: Leave the money where it is.

If your employer allows you to leave your money in their retirement plan even after you've left the company, this is one option to consider. This is the case with TSP, where money can remain in the TSP account even after leaving the military.

If you're considering leaving your money where it is, ask yourself the following questions:

1. How competitive are the investment fees and other costs?

Each investment has some sort of fee attached to it, and accounts often have annual maintenance costs. While fees are not the only thing to consider, they are important because they lower returns. Low fees are one of the main benefits of TSP. While they are low, take note that TSP fees will be lower than some investments but can be higher than others.

Do some research to determine whether the fees and costs associated with your old employer's account are competitive, or whether you have options with lower fees.

2. Am I satisfied with the investment options and performance?

Even if satisfied, it's useful to consider alternatives. But when considering alternatives, remember that past performance is no guarantee of future results. Take care to do an apples-to-apples comparison. A qualified financial advisor can help if you need it.

3. Am I happy with the service I'm receiving?

If it feels like there are a lot of barriers to getting good service — or even getting answers to your questions — consider other options where you have access to better service.

4. What are the other intangibles I should consider?

If you have a TSP account, you have the ability to provide a lifetime income stream, known as annuitization. The TSP option is nice because the TSP benefit payout may be better than what you might receive from a private insurer.

But remember that only funds in the TSP account can be annuitized. The TSP has an option where you can move your funds out of the account and keep the account open — as long as you leave $200 in it. Then you can move funds back into the TSP at a later date and annuitize it if desired.

Consider market volatility when you determine how much money to leave in the TSP. If market volatility or losses cause the account to drop below $200, the account will be closed. So you might want to leave a higher balance to provide some cushion.

If you have an employer retirement plan, your employer may permit you to take out a loan. This is not an option with an IRA. For example, if you roll your money into an IRA, this option goes away and if money is needed, your only option is a withdrawal.

However, if you roll your money into your new employer's 401(k) and the new plan allows for it, this option is back on the table. This is something you should consider if you believe you'll need a loan from your 401(k) in the near future.

Option 3: Roll your money over into a new account.

A rollover can take one of two paths: Move the funds into a new employer retirement plan or roll the funds into a similar IRA.

If you decide to move the funds into a new employer retirement plan, consider keeping your assets in one place so they are easier to track. This can make it easier to assess risk tolerance, performance and diversification.

As outlined above, be sure to analyze the fees, service, investment options, investment performance and intangibles. If the new plan has higher fees and subpar investment options or performance, an alternative may be better.

If your new employer doesn't accept funds from your previous employer, you can take the second path. Remember that traditional 401(k) funds go into a Traditional IRA and Roth 401(k) funds go into a Roth IRA.

The same logic applies for a 403(b) or TSP. You may have to open two different accounts, depending on the mix of your retirement plan funds.

With this type of rollover, the sky truly is the limit. Providers offer a multitude of investing options, many that might not be available through employer plans, such as Socially Responsible Investments or individual stocks and bonds.

Once again, more options do not always mean better options. More options are not always necessary to achieve diversification and manage risk within a portfolio.

What if you have an existing loan from your employer's retirement plan?

Whether you leave your current employer voluntarily or they terminate your employment, the IRS requires you to pay back the 401(k) loan in full, according to 401kmanuever.com. Under the Tax Cuts and Jobs Act, or TCJA, 401(k) loan borrowers have until the due date of their tax return to pay back a loan from their employer's retirement plan. Prior to TCJA, loan borrowers had 60 days to pay it back.

If you don't pay back the full loan balance, the IRS considers it to be a withdrawal. It's subject to the rules that apply to you at that time as far as taxes and penalties that might be due.

Direct versus indirect rollovers

As you move funds from one institution to another, you have two choices: a direct rollover or an indirect rollover.

In a direct rollover, funds transfer directly from one institution to another, bypassing the account owner, which is probably you. With an indirect rollover, on the other hand, funds first come to the account owner who's responsible for depositing them with a new institution.

If you decide to go with an indirect rollover, 20% of your portfolio's value is automatically withheld for taxes. If you don't deposit the withdrawn amount into the other account within 60 days, the IRS will consider it a distribution. As with any distribution, the rules of the account apply as far as any penalty or taxes due. Let's look at an example.

Example of an indirect rollover

Consider a person who gets a new job and decides to roll over $10,000 from their employer retirement plan to an IRA. If they opt for the indirect rollover, they'll only receive a check for $8,000 because 20% was withheld in taxes.

However, this person must deposit the entire $10,000 into their IRA within 60 days to avoid a 10% penalty and potential tax consequences, unless they have a qualifying exception. That means the $2,000 must come from their own money. All this will be sorted out come tax time. In the meantime, they must make up the $2,000 difference with other funds, which is probably savings.

Let's say the account holder is unable to make up the difference and they only deposit $8,000 into the new IRA. In that case, $2,000 will be reported to the IRS as a distribution. If they are younger than 59 ½ and don't have a qualifying exception, they'll pay a 10% penalty in addition to any taxes due.

That's why a direct rollover is favorable. It avoids the penalty altogether by making the transfer directly from one account to another.

The right choice: What do I do with my retirement plan?

What to do with your employer retirement plan when you retire or change jobs comes down to your individual circumstances. Every person has different options, investing choices, fees and needs.

However, we can all agree that withdrawing the money and using it for non-retirement purposes is the most drastic path to take.

Not only does that decision have the most damaging financial consequences, but it also changes the purpose of those funds. Your future self is relying on those funds for day-to-day living in retirement. Make a commitment to yourself to keep your retirement money safe and secure.