Retirement Basics
An egg and money in a bird's nest with at $1 bill in the background
Leave 401(k) or roll it over?

However, the savings of a 401(k) plan can be wiped out if an employer-based plan offers mutual funds that charge high fees. So, for example, it's important to understand all the expenses of your company plan before deciding whether to keep the money in your 401(k) or roll it over into an IRA with a provider of low-fee index mutual funds.

People who keep their money in an old 401(k) may benefit from other advantages. For example, they can borrow against their funds in the event of a financial emergency, says Hess.

For those nearing retirement, Hess notes there may be an added incentive for leaving your funds in a 401(k) -- especially if you expect to begin tapping your nest egg before age 59 1/2. That's because the IRS allows retirees to begin penalty-free withdrawals from their 401(k) accounts beginning at age 55.

If you withdraw money from your IRA before age 59 1/2, you'll pay ordinary income tax plus a 10 percent penalty.

Rolling over your money

However, there are also potential drawbacks to leaving your money in an old 401(k). As mentioned previously, some 401(k) plans offer mutual funds that charge high fees, which can eat into your returns over time and leave you with less money once you retire.

Another drawback to leaving your 401(k) money with former employers is that you can easily accumulate a half-dozen accounts by the time you reach retirement.

That makes managing your portfolio tough.

Another disadvantage is their lack of flexibility -- the vast majority of 401(k) plans restrict investors to mutual funds and company stock.

That's where IRAs come in.

Both traditional and Roth IRAs offer a wide variety of funds, individual stocks, bonds and certificates of deposit from which to choose.

"The fact that you can essentially invest in almost anything is a major benefit with IRAs," says Nick Kaster, senior analyst for CCH, a tax services firm in Riverwoods, Ill. "With 401(k)s you're limited to investments that your employer provides and, in some cases, they may not be good."

Those who opt to roll their fund into a traditional IRA pay no upfront taxes, although they will pay tax on their withdrawals during retirement.

Those who roll over into a Roth pay their taxes upfront, but the earnings grow tax-free.

Roths are often recommended for younger employees with lower incomes, who may choose to pay taxes on their contributions today and enjoy tax-free withdrawals down the road. 

They are also well-suited for those who may need early withdrawals for non-retirement related expenses.

The Internal Revenue Service allows retirement savers under age 59-1/2 to withdraw the earnings portion of their Roth IRA penalty-free as long as the account has been open at least five years and the money is used for qualified expenses, including the purchase of a first home, higher education or medical cost. The original after-tax contribution to a Roth -- your principal -- can be withdrawn without penalty at any time for any reason.

The contribution amount allowed for Roth IRAs, however, begins to phase out for joint filers with incomes exceeding $156,000 in 2007 ($159,000 in 2008), and for singles and heads of households with incomes exceeding $99,000 in 2007 ($101,000 in 2008).

Whatever IRA you choose, remember to instruct your employer to complete a "direct rollover," where your money gets moved from your 401(k) to your IRA without touching your hands.

Withdrawing the money yourself would be viewed as a cash distribution, and taxed and penalized accordingly.


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