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.
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
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
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.