What to do? Keep my 401k or roll it over?
At the top of your list of decisions to make when you are switching jobs or retiring is whether to stay in your employer’s 401(k) or roll it over into an IRA. In most cases, you wouldn’t want to simply cash in your retirement account, since you face paying income taxes and penalties. You also lose the ability to grow your investments tax-deferred. If you are job switching, you may well decide to simply roll over your retirement plan to your new employer’s 401(k). But let’s consider the options before taking action.
Option #1 Leave your 401(k) account where it is. If you select this option, you are not alone. Roughly one in three workers do so, according to the Employee Benefits Research Institute. Their reasons: it’s easier because you don’t have to deal with the paperwork and there’s less chance of making a costly mistake.
Whether you keep it with your former employer or move it to a new employer’s plan, your 401(k) carries with it creditor protection. Federal law prohibits creditors from invading 401(k) accounts. The law does not protect IRAs, though some states shield IRAs from creditors.
If you leave work due to termination or retirement, you usually can begin withdrawing from a 401(k) as early as age 55 without the early withdrawal penalty, which is a hefty ten percent. In most cases, with an IRA, you will have to wait to age 59 1/2 for penalty-free withdrawals.
Did you know that 401(k) plans are more likely to offer stable-value mutual funds than IRAs?[401(k) investing computer file, p 29] If you are a conservative investor, you will like the healthier yields they provide over money markets.
Your investment choices are more limited in a 401(k) than with an IRA. Why might this be an advantage? Some studies show that investors who trade a lot hurt their personal returns more than those who don’t trade as often. Thus, investors who are tempted to trade, or who are so overwhelmed by too many investment choices they actually do nothing, may be better off sticking with their 401(k). Of course, the quality of the investment options your particular 401(k) offers also needs to be considered.
Unlike IRAs, you can borrow from a 401(k) if you’re still working for that employer. Financial planners generally discourage borrowing from a 401(k)—the borrowed money no longer grows tax deferred and there’s a risk you won’t be able to repay it in time, resulting in heavy taxes and penalties. Still, it is an option that often beats borrowing from a credit card.
You’ll need to keep an eye on your 401(k) account. Employers have the option of cashing out defined-contribution accounts that are valued at $5,000 or less if you fail to take action. That’s changing beginning on March 28, 2005, however. For accounts valued from $1,000 to $5,000 the employer will have to roll your money into a default IRA unless you specify otherwise.
Option #2 Rolling over to an IRA. As mentioned, IRAs are known for having a lot more investment choices than 401(k)s. That’s a benefit if you are a prudent investor. You also will not have to worry about future investment options changing, as they often do in employers’ plans.
If being organized is not your thing, you may be discouraged with all the accounts and paperwork you will accumulate with employer retirement accounts. You may even lose track of some of them, especially if you change jobs often. A single IRA is easier to manage, or you could even consolidate your IRA into your current employer’s plan if it’s good quality.
Tax savings are where IRAs shine. For example, you are allowed to designate a younger non-spousal beneficiary and “stretch out” the minimum withdrawals over that person’s lifetime. With most 401(k) plans, your account would immediately have to be cashed out if your heir is not your spouse, resulting in a much larger tax bite and loss of further tax deferral.
In addition, with a rollover IRA, you may also be in a position to convert to a Roth IRA. This is a good option for many individuals.
Provided by courtesy of Herb White, MBA, CFP, Principal and Managing Director of Life Certain Wealth Strategies in
