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Deciding to take on a new phase of your career is always a serious decision. For some, this means training for a new specialty or taking a job with a new employer. However, with the changes we all experienced over the last year, it’s no surprise that thousands of professionals are taking their careers into their own hands. As private contractors, consultants, and experts in the gig economy, many of us are considering or already have transitioned to an entrepreneurial lifestyle.

Becoming self-employed is a big financial transition. While the logistics of work may have become simpler, you have some important decisions to make about money – especially your 401K and any other long-term retirement account once provided by your past employer(s). When you move to a new employer, it is usually a smart idea to roll your past 401k accounts to the new employer so that all those retirement funds are accruing interest together instead of separately. But what happens when you are suddenly self-employed and don’t provide yourself a 401K matching plan?

That is exactly what we’re here to explain today.

Quick Answer to Entrepreneur 401K

You will need to transfer your 401K account or accounts to a private IRA account and manage it independently. The correct transfer procedure will protect you from early withdrawal penalties or taxes by cleanly keeping all of your retirement funds in a retirement-designed savings account. This transfer does not need to happen immediately, and your current 401K can remain with your last employer until you are ready to create then manage your self-employed retirement plan and IRA account.

How Employer 401Ks Work

A 401K is a unique type of bank account designed specifically for holding retirement funds. These are funds not meant to be touched or withdrawn until your legal retirement age. If the funds are removed or accessed before then, fees and other penalties will apply.

In terms of taxation, your income tax each year does not include the amount added to your 401K. Instead, your 401K and other retirement accounts have deferred taxation. This means that income tax is paid on 401Ks when the money is withdrawn. This helps to keep your now-taxes lower and also provides a regular income for you later in life after retirement age.

It’s also useful to know that each individual employer handles retirement accounts differently. Some receive better returns; some offer better matching. As your own boss, you will also be responsible for how you handle your private retirement account.

Rolling a 401K to a New Employer

When a professional transitions to a new employer, their 401K does not automatically follow. Instead, professionals will need to submit the right forms and have their 401K account transferred to a new 401K account owned by the new employer. With the transfer done correctly, the funds from previous employer retirement benefits will roll neatly into your current employer’s retirement benefit.

Many professionals have a Pac-man trail of 401K accounts behind them, never rolled forward or collected. Over time, the 401Ks of moved-on employees are dropped from an employer’s finances and often left as IRA accounts with a local bank. If you’re looking to roll in an old 401K, keep this possibility in mind.

But what about rolling a 401K forward when you are now self-employed? For this, you can choose one of two options. You can leave it with your last employer (for a while), or you can open a private retirement account and transfer everything forward into your direct control without initiating early-withdrawal penalties.

Past 401Ks and Working For Yourself

Working for yourself means handling your own schedule, workload, and clients. This can be freeing, but you are also in charge of all your employee benefits. Just as you must provide yourself a health care plan, you are also responsible for your own retirement savings. To do this correctly, you need an active retirement-ready account with deferred income tax and management for long-term returns.

To do this, you can stick with your latest employer’s provided account – not yet rolled into an IRA – or you can make your own IRA as live retirement account for the entrepreneurial stretch of your career.

Keep It With Your Last Employer (For Now)

Should you keep your 401K with your employer when you go solo? If your last employer had a good 401K management program, and if they allow you to add new income to the account, then it might be a good idea to leave your retirement funds where they are – for the time being. If you are not yet ready to start paying into a retirement fund with your entrepreneurial income or if you’re not sure how long this solo phase will last, it’s often the most stable decision to leave your 401K with your most recent business employer.

Open a Private IRA

If you are ready to fully claim all your past 401Ks as a solo professional, then open an IRA. IRA stands for Independent Retirement Account, as it is the type of government-approved retirement account that provides deferred income taxes to independent professionals.

Just as you could roll your past 401Ks to a new employer’s retirement account in your name, you can roll them into your own IRA instead. This allows you to make your own decisions about how your IRA is invested and managed. Not only do you have full and active possession of your previous retirement savings from past employers, but as an entrepreneur, you can now decide how that savings is managed to generate returns before your retirement.

Working with a Financial Manager to Build Your Entrepreneur IRA

To gain the greatest benefit from your now-private retirement funds (and to avoid penalties), most professionals hire a financial manager. As an entrepreneur, it’s smart to have a financial expert on your team to ensure that both your personal and personal-business finances make the transition safely.

Part of this is ensuring that your retirement funds from past employer accounts are rolled forward accurately. Transferred correctly, you avoid fees and income taxes as all previous retirement savings become one. Your financial manager will then help you determine the best ways to manage your amassed retirement savings to generate satisfying returns over time.

Have you recently made the transition to self-employed? Are you planning to become a solo contractor or business owner in the near future? We can help. Contact us today to consult on your business and personal financial plans and how to manage your 401K as your own employer.