Moving Your Retirement Accounts

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No matter what the economic climate when you retire, you’ll want to make sure that you handle your retirement accounts gingerly.

Nest eggs are fragile; they’re often most vulnerable in transit. When leaving your job, deciding what to do with your workplace retirement plan can be challenging because you have so many choices.

You could leave the 401(k) with your old employer. Or you could move it into another workplace plan if you decide not to retire after all. Or you could stash your workplace plan in an individual retirement account.

Use this freedom strategically: You could be taking a step backward if you don’t make the right move.

So how should you proceed? It depends on your circumstances, but I’ve made it easier to sort out by highlighting the main choices for a retiree: (1) establish an IRA rollover, (2) leave the 401(k) behind with your employer’s plan, or (3) cash in sort of.

Roll Over

For most people, creating an IRA rollover account is a slam dunk. Once the money from your 401(k), 403(b), or 457(b) is moved into a rollover, it’s sheltered from taxes as long as it remains undisturbed. It’s an excellent way to consolidate your nest egg because retirement savings can be corralled from different jobs into one place.
An IRA rollover, which you can establish at just about any financial institution, can provide a safe haven for workplace plans that are stuffed with bloated fees and ugly investment choices. An investor who rolls the cash into an IRA can assemble a low cost retirement portfolio with the investment options in my recommended portfolios. (You can find these portfolios in Appendix B.)

When transferring money into an IRA, don’t request a check from your company. While it’s perfectly legal to do so, you are courting disaster. That’s because you must move the money into an IRA within sixty days of receipt of the check. Not sixty one days. The Internal Revenue Service is a real stickler on this.

If you miss the deadline, you blow the tax protection. Taxes will be owed on the full amount. If applicable, you’ll also be hit with the 10 percent early withdrawal penalty.
The prudent course is to move the money to an IRA by way of a trustee to trustee transfer. This simply means that your company will send the money directly to the financial institution that you designate.

Leave the Money in Your Present 401(k)

Some people keep their 401(k) parked at their former workplace (s), but that’s usually not a judicious move. A retiree’s investment choices are generally superior and cheaper in an IRA rollover.

If you’re going to need your 401(k) money soon, leaving it with your prior employer could be wise. Many people don’t realize they can withdraw funds from an old 401(k) without getting smacked with the early withdrawal penalty as long as they’ve reached their fifty fifth birthday. Once the money is rolled into an IRA, that 10 percent penalty will be lurking until they are fifty nine and a half.

Remember, your age won’t insulate you from paying federal and state income taxes on any withdrawal from a 401(k) or other workplace plan.

Take the Money and Pay the Tax

Take your money now, and taxes will obliterate your nest egg. When cashing in your workplace retirement fund, you’ll owe federal and applicable state income taxes and don’t forget that early 10 percent withdrawal penalty, if applicable. Ultimately, 40 percent or more of your hard-earned money could easily get chewed up by the IRS.

If you’re still picturing that splattered nest egg, the next advice might seem odd: Sometimes it makes financial sense to avoid escorting everything in your old 401(k) into an IRA rollover. For instance, appreciated company stock presents a special case.
Here’s why.

If you stash all your company stock in an IRA rollover, you’ll be taxed at your ordinary income tax rate when you sell the shares and withdraw the cash during retirement. Currently, this can be as high as 35 percent.

Here’s a better idea. Ask your retirement plan administrator to distribute the shares to a taxable account.

What about the 10 percent penalty? You’ll have to pay it if you haven’t reached that magic age of fifty five, but it won’t be as painful as you’d expect. That’s because the penalty is tied to the stock’s cost basis and not its current value. If the cost basis of your stock is $8,000 but it’s now worth $75,000, you’d pay $800 for the early withdrawal penalty, not $7,500.

Here’s the benefit of this strategy: By transferring the shares to a taxable account, you will pay only the capital gains tax on the difference between the cost basis and the current value of the stock when you sell the shares.

The tax savings could be meaningful.

Before choosing this strategy, think long and hard about holding on to your company stock.

Owning shares of individual companies can be a financial time bomb. Ask General Motors employees. During the late 1990s, GM stock was selling for $90 a share; near the end of 2008, shares were selling for as little as $3.

Holding a concentrated position in any stock is extremely risky. Most investors would be far better off if they sold their company stock, paid the taxes, and invested the proceeds in a properly allocated, broadly diversified portfolio of low cost index funds.

What’s the Point?

Most employees would be better off rolling over their old 401(k) into an IRA.


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