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Three years ago, R. Boeding retired from
his 35-year job with an electric company. His employer gave him a choice: Take his
$450,000 retirement fund all at once or let the company pay out fixed amounts over time
from his account.
He faced the question many retirees and job
hoppers face: Do I leave my money in my retirement plan, cash out, or roll it into an IRA?
That's a big decision and making the wrong one can be costly.
In Boeding's case, if he had chosen to let the company pay
him fixed amounts, once he died, his wife would have received only half the amount. This
made the decision easy for him.
"It was a no-brainer," said Boeding, who was 55
when he retired. He wanted the money so he took the lump sum, which he then rolled into an
IRA.
If you are in a similar situation, you might want to
consider rolling your money into an IRA because it will enable you to continue to keep
your money sheltered from tax as well as continuously invested. Here's the lowdown on when
and how you can take the money, and why you might want to.
When to Roll Your 401(k) into an IRA
You can roll your 401(k) money into an IRA only in certain
circumstances. Those are: when you quit or are fired from your job, or retire. You can't
roll over your 401(k) funds into an IRA while you are still working for the same employer
just because you don't like the investment choices in your plan.
Why Roll Your Money Over
The rationale for rolling 401(k) money into an IRA may be
different for retirees than for folks still in the work force. There are a few general
issues to consider as well. We'll take a look at the issues you need to consider in each
case.
In general
Take control: Regardless of whether you're changing
jobs or retiring, rolling your retirement money into an IRA gives you control of it.
"Without a doubt, when you leave a company, take your
money with you," said Michelle Anderson, vice president of personal investment
counselors with First Union Brokerage Services, Inc. "If you roll into an IRA, you
get the money 100 percent in your control. ... (It) can let you access any investment you
want. You aren't limited," she said.
Say you didn't like the investment choices with your 401(k)
plan. With a rollover IRA, you may have much more flexibility in your investment options.
Indeed, Boeding took advantage of this investment freedom.
At retirement, Boeding saw a financial planner who advised him to invest in equity-based
mutual funds. He did so and managed to catch onto the recent bull-market run in the stock
market.
"The portfolio is doing a good job ... and is growing
$650 a month," he said.
Get more data: You get more information about your
investments when they're in an IRA rather than in a 401(k). Federal law is not nearly as
strict with 401(k) plans as it is with IRAs when it comes to requiring distribution of
informational materials about the funds.
"The information ... that a 401(k) plan has to give to
participants is limited," compared to an IRA, said Greg Thurin, district manager and
personal financial advisor with American Express Financial Services.
Another reason you might want to move the money is that IRA
account administrators, who are competing for your business, tend to be more responsive
than 401(k) administrators and plan sponsors. Thurin recalls trying to help a client with
a 401(k) set up a personal identification number to use over the toll-free number.
"It took 15 minutes to establish a ... number," he said.
Simplifying recordkeeping: With a rollover IRA, you
can consolidate money from various plans into a single account. In turn, this can simplify
recordkeeping.
In today's fluid job market, folks regularly change jobs.
Consequently, they end up with money scattered among several retirement plans. With a
rollover IRA, it can all be brought together, and that can really reduce the number of
mailings you get from fund companies. "You can receive one statement, which would
make understanding your investments easier," said Richard Casolari, managing partner
of Executive Financial Group, a Chicago-based financial-planning and insurance-service
company.
Retirees
Say it's your last day of work. As you finish your exit
interview, the human resources person asks what you want to do with the money in your
401(k) plan.
You reply, "I was thinking about buying a new boat or
taking a cruise around the world."
The manager says, "That's not what I mean. Do you want
to roll it over into an IRA, or should I write you a check?" (If you have more than
$5,000 in the account and you're under 65, you should also be able to leave the money in
the plan; but your withdrawal options may be less flexible. You may also be charged an
annual account-maintenance fee.)
Your answer could mean the difference between a paying a
big tax bill or not. If you take a lump-sum distribution, you will have to pay tax on it.
If it is a large amount, it will probably push you into a higher tax bracket.
However, if you chose to directly roll the money into an
IRA, you won't have such a big tax hit. The money will smoothly move from one
tax-sheltered account to another. Further, you can arrange to make regular withdrawals
from the IRA so that you are taking out smaller amounts of money and paying less tax.
Additionally, if you roll your 401(k) money into an IRA, it
can stay invested and continue earning profits, tax deferred. If you take the money
directly, you then have to open an investment account, and you will have to pay taxes on
all profits you earn from that point forward.
Current workers
Many workers don't know about their options. They
completely cash out of the plan, pay a big tax bill, and deplete their retirement savings.
"You will lose half of your money if you cash
out," said Gary Hooker, a certified financial planner and CEO of Diversified Planning
Concepts, a San Francisco–based financial-planning firm. "Why take that big a
hit? I've never seen any reason to take your money out unless you are starving."
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"You will lose half of your money
if you cash out. Why take that big a hit? I've never seen any reason to take your money
out unless you are starving."
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| — Gary Hooker,
CFP, CEO of Diversified Planning Concepts. |
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One caveat, regardless of your situation, some 401(k) plans
won't let you take your money out until you reach 59ý. Check with your plan sponsor to
find out the rules for your specific situation.
Here's why you should consider rolling the money into an
IRA if you change jobs:
- It keeps your money working for you on a tax-deferred basis.
- You continue to take advantage of the compounding power of
your retirement money.
- If you cash out, you not only have to start over building a
new retirement-fund balance, but you also lose out on the time value of money. All those
years your money has been compounding in your old account will be lost, and you can never
recover that.
How to Do It: Two Easy Steps
The best way to do a rollover is through what is known as a
trustee-to-trustee transfer, Casolari said. By using this process, your money goes
directly from your employer to your new IRA custodian. Your money stays within the
protective envelope of tax-deferred accounts.
"If the check is payable to (the employee), the
employer has to withhold 20 percent for income tax," Casolari said.
If you take a lump-sum distribution and end up rolling the
money over into a tax-deferred account, you won't get back the 20 percent withholding
until you file your tax return for the year.
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"I've seen employers take 90 to
120 days to send the money."
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| — Richard
Casolari, managing partner of Executive Financial Group. |
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So, before you withdraw the money from your 401(k) plan,
the first thing you want to do is set up a rollover IRA with a trustee. You need to do
this so you will have an account number to give your former employer.
Next, you fill out the proper paperwork with your employer
requesting a withdrawal from your 401(k) plan. At this point, give the plan-sponsor
account number and ask to have your balance sent straight to the new account.
After the money is in the rollover account, you can invest
it as you choose and start taking regular withdrawals as well.
Indeed, Boeding arranged with his financial advisor to take
regular distributions from his IRA for five years, to avoid the early withdrawal penalty
since he was under 59ý. At age 60, Boeding plans to sit down with his financial advisor
to review his account and see if he wants to change his retirement strategy.
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| IMPORTANT TIP |
Save several months' worth of salary in a
personal savings account for living expenses while you're waiting for your 401(k) money to
be sent to you. It's common for it to take two months or more to receive your money.
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"Most people don't have a clue about this," said
Casolari. "I've seen employers take 90 to 120 days to send the money."
Pitfalls and Concerns
If you are using a rollover IRA to hold money while you
wait to enroll in a new 401(k) plan, don't make any other contributions to the account. If
you do, you will taint the 401(k) money. A new employer won't be able to accept your money
because the funds will be commingled. Any employer accepting that money might have its
401(k) plan disqualified.
When you roll 401(k) money into an IRA, you lose the
ability to take a loan against the account, said Thurin.
"A loan can only be taken if you are an active
employee with that company," he said. But he also pointed out, losing that loan
function is no great loss.
"The 401(k) plan is the worst place to take a
loan" because it means borrowing against your retirement future, adds Thurin.
"Most people don't realize that," he said. |
