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Ask Dr. DonUsing 401(k) funds to invest in individual stocks

Dear Dr. Don,
I want to roll over some of my 401(k) so I can invest in individual stocks. I have a sizable amount tied up in my company 401(k). The funds are doing reasonably well, but I feel I can take a portion and gamble on some of the peak stock performers such as Sun Microsystems. I understand that I can rollover some of my funds into an IRA account that allows me to invest in an individual stock. Is this the best way? If so, do you have any recommendations on the best way for me to do it? What IRAs might allow this? At what price to me? What would be the downside? Are there other methods besides IRAs that might be logical? Thanks in advance.
Bill Bonds

Dear Bill,
If you aren't changing jobs, you can't do a rollover or partial rollover out of your employer's 401(k) plan into another type of tax deferred retirement plan. Your investment choices are limited by the plan. You can reallocate the portfolio among permitted investments but can't go outside the plan for investments.

When you leave a company, one of your choices is to do an IRA rollover, moving the investments in your 401(k) into an IRA account. That IRA account can be set up as a brokerage account where you can trade individual stocks and bonds. An IRA brokerage account allows you to trade in that account without a tax effect on your annual income taxes. That's because taxes aren't paid until the money is distributed out of the account. Distributions are then taxed at your ordinary income tax rate.

There is one tax advantage to holding stocks outside your retirement accounts. Long-term capital gains realized on stock sales in a taxable brokerage account will pay a maximum 20 percent in capital gains taxes.

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Rolling over into an IRA CD

Dr. Don,
I'm leaving a company where I've worked for 11 years. I've gotten control of my 401(k) and am waiting on my personal retirement account check. I already have a small traditional IRA and a Roth IRA and am wondering if I'm allowed to put this new check into something like an IRA CD?

My biggest concern is not having to pay taxes on it until I'm 65. I'm 58 and expect to be working for another company with a different 401(k) plan soon. Boy, is this all confusing me.
Al Avoidance

Dear Al,
You can put the money in an IRA CD without generating any tax obligations. (You can use this site's Best Rates feature to find the best rates nationally on IRA CDs.) Tax-deferred contributions won't be taxed until they are distributed out of the account. Moving your money from one tax-deferred retirement plan to another isn't considered a taxable distribution. To do this you want to effect a direct rollover from your 401(k) to your IRA account. That means that the check is made out to the IRA provider. Tell your plan administrator that you want to do a direct rollover.

If the distribution check is made out to you, the check will be subject to mandatory withholding. The mandatory withholding is considered a taxable distribution out of your 401(k). To invest the full balance of your 401(k), and avoid a tax liability, you have to come up with an amount equal to the dollars withheld to invest in the IRA account along with your distribution check. SmartMoney.com can give you additional information on how to avoid the 20 percent withholding trap. Don't forget that the 401(k) money has to be deposited in the IRA account within 60 days of the date on the check to avoid being considered a distribution out of the 401(k).

But if part of your 401(k) is invested in company stock, there are some tax advantages to not cashing in the shares and rolling the proceeds into an IRA or another company's 401(k). Not all companies offer a lump-sum distribution option for company stock so you'll need to check with your plan's administrator. If this is an option, ask your tax professional to help you decide if a lump sum distribution of company stock is the right decision for you. An article in TheStreet.com helps explain this option.


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