Ask Dr. Don By Don Taylor, Ph.D., CFA • Bankrate.com

Transferring 401(k) savings in an IRA

Dr. Don,
About three months ago, I lost my job with Montgomery Ward. I had a savings plan and a 401(k) plan with them. The 401(k) included various stocks with GE.

I was told that all I could do is either cash out or roll it over into an IRA account. I already have a traditional IRA. What should I do? I keep on reading different ways to roll it over.

And where would you suggest that I roll it over? I have less than the minimum amount to be able to leave it where it is, and my new job says that I have to be there a year.
Thank you,
Debbie Decisions

Dear Debbie,
Avoid the temptation to just take the money and pay the taxes and penalties.

Most employers require you to close the account if you have less than $5,000 in the account. Keep your options open by doing a direct transfer into an IRA Rollover account. If you keep the money separate from your traditional IRA account you'll be able to move the IRA rollover account into your new employers' 401(k) plan after you've met their length of employment requirement.

A direct transfer means the money is transferred from the 401(k) account directly into the IRA Rollover account.

If you accept a check, then the money in the account will be subject to mandatory withholding. That means that 20 percent of the money in the account will be sent to the government. Fully funding the IRA rollover will then require you to come up with an amount equal to the withheld amount to deposit with the check. Otherwise the withheld amount will be treated as an early distribution and is subject to income taxes and a 10 percent penalty. It's much easier to just do a direct transfer.

Where to transfer the money? There are literally thousands of choices. Remember that you aren't obligated to later roll the money into your new employer's 401(k) account. It can stay in the IRA Rollover account. My rule of thumb for small investors is to concentrate your investments in diversified mutual funds. If you have $5,000 to invest you don't need five mutual funds. One or two will be just fine.

I suggest that you deal directly with a no-load mutual fund family like Dodge & Cox, Federated, Fidelity, Janus, or Vanguard. You're trying to manage the annual expenses in the mutual funds, avoid sales loads and not invest in annuities.

Morningstar is a good site to shop for mutual funds. Some small investors like the idea of a hybrid fund that invests in both stocks and bonds. Two examples of this type of fund are Vanguard's Wellington Fund and Dodge & Cox's Balanced Fund.

-- Posted: Aug. 7, 2001