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401(k)s: To roll or not to roll?

Chances are, if you are changing jobs, the last thing you're thinking about is your 401(k). Big mistake. Sure, it's your money, but it won't follow you like a puppy. However, with just a little planning, you might be able to get it to do a few new tricks.

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If you have a 401(k) plan with your company and you're changing jobs, you basically have four options:

Option 1: Cash out and buy a car/boat/condo and/or a really cool entertainment center.
Sounds dumb, right? But some people do it. Even if your goals are altruistic -- slaying the dragon of credit card debt -- think again. With credit cards, you might be facing a 21 percent interest rate on your debt. But when you tap 401(k) money, not only do you pay income taxes on the money at, say 27 percent, you also pay a 10 percent penalty, plus any state and local taxes -- making that some pretty expensive cash.

Wayne G. Bogosian, managing director of the PFE Group, a financial education firm, and co-author of The Complete Idiot's Guide to 401(k) Plans, estimates that, depending on the tax bracket, cashing out could cost an employee 40 to 60 percent of their 401(k) savings.

In addition, if you've taken out a loan against your 401(k), most companies will demand that you pay it back -- in full -- within 60 days of leaving. If you don't, you'll be liable for federal and state income tax, plus a 10 percent penalty on the amount you borrowed. Even if the company is willing to give you more time, you may have to leave your money in the plan until you've repaid your loan. Check with the plan administrator and get the answers in writing.

Option 2: Roll the money into a traditional Individual Retirement Account or IRA.
Changing jobs is a golden opportunity for you and your 401(k). This is the only time you are allowed to take your retirement money and invest it on your own. After evaluating your new employer's 401(k) plan, you may decide you'd rather put the money into a traditional IRA. "When you look at a 401(k), you're looking at what's good for a lot of people," says Lorayne Fiorillo, a registered investment Adviser and the author of Financial Fitness in 45 Days: The Complete Guide to Shaping Up Your Savings. "When you roll it into an IRA, you can do what's good for you."

If you elect to open an IRA, keep the money separate or mix it only with other 401(k) or company-sponsored retirement fund money. That way, if you ever decide that you want to roll it back into a company-sponsored retirement plan, you have the option. Once you mix it with money that you've set aside apart from any employer plan, the money is considered tainted and can't be reinvested in a company plan. "The most important rule in financial planning? Always keep your options open," says Bogosian.

One caveat: are you expecting to be sued or working in a profession that puts you at risk for lawsuits? While 401(k)s are sheltered from legal action, IRAs are not. If you think you could be the target of a lawsuit, roll your money into your new company's 401(k) plan.

Whether you choose an IRA or roll your money into a new 401(k), make sure you never, ever get custody of the check. In either case, let your former employer wire the money directly to the custodian of your new plan. Otherwise, the IRS assumes you've cashed out, and you will be docked accordingly.

Option 3: Keep the money where it is.
If you have more than $5,000 in your 401(k), your soon-to-be-former employer can't kick you out of the plan. While you can't continue to make contributions, you can keep your money there as long as you like.

While this may be a great temporary solution -- giving you some time to investigate your options before you jump -- many experts shy away from leaving the money permanently in the care of a former employer. "Twenty years from now, how important will you be to them?" says Ric Edelman, a financial Adviser with Edelman Financial Services and author of "The Truth About Money." In addition, since most Americans work for small employers, what are the chances the company will still be alive and solvent?

Option 4: Roll your old 401(k) into your new employer's 401(k) plan.
If you don't like to think much about your money, this is probably the safest option. But before you sign on for the new job -- ask some questions. First of all, will the company allow you to roll your money in on day one? If not, you may have to leave your money in your former employer's plan or open a traditional IRA to hold the money until you're allowed to roll in your nest egg.

Second, do you like your new employer's plan? How many choices do you have for investing? Does the company invest only in its own stock? How much of the money goes into the plan and how much goes to manage the plan? Do you like it as much as your old plan? Could you do better opening an IRA?

"Most people forget to look at their new employer's 401(k) plan," says Chris Farrell, contributing editor at Business Week and host of Right on the Money, a public television personal finance series. "If you don't like it, it doesn't mean you won't take the job, but go in with your eyes wide open."

Third, when can you actually participate in the plan with your new employer? Don't slack off from saving for your retirement just because there is a waiting period. Take the opportunity to open your own IRA and set aside whatever you would have saved.

One reason not to roll over your nest egg: company stock. If you've accumulated stock and you want to hang onto it, you can't roll your old 401(k) into a new plan. Instead, advises Bogosian, put any 401(k) money into an IRA and park the stocks in a brokerage account. You'll only be taxed for the amount that it was worth when you bought it -- not what it's worth now. And when you sell the stock, you'll be taxed at capital gains rates, which are generally lower than income tax rates.


-- Posted: Aug. 5, 2003




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