In the past, many people stayed at one job, or at least one company, for almost their entire working lives. When they retired, they could typically count on a pension, the value of which was based on their years of service and earnings.
Today, workers can expect to hold several jobs in their lifetime, and to a great extent, pensions have been replaced by 401(k) plans, which place much of the funding responsibility on employees.
So, assuming you will change jobs at some point, and you do have a 401(k), what should you do with it?
Here are your basic choices:
• Cash out your plan. If you do this, your company will likely pay you 80 percent of your account value, withholding the rest for federal taxes. And if you’re younger than age 59½, you may be slapped with a 10 percent IRS tax penalty. Even worse, you’ll have lost a key source of your retirement income. Still, if you are leaving your employer involuntarily, and you need the money, cashing out your 401(k) is an option you may need to consider.
• Keep the money in your company’s plan. When you leave a company, your employer may allow you to keep your money in your existing 401(k). You may want to choose this route if you like the investment choices available in your plan. However, you might be caught by surprise if the company decides to change investment options. Furthermore, some employers may charge former employees fees to maintain their 401(k) plans.
• Move the money into your new employer’s plan. If your new employer has a 401(k) and allows transfers, you could roll the money from your old plan into the new one. This might be an attractive option if you like the investment options in your new employer’s plan.
• Roll the money over to an IRA. You may find several advantages to rolling your 401(k) over to an Individual Retirement Account.
First, your money will still have the potential to grow on a tax-deferred basis.
Second, you can invest your funds in virtually any investment you choose — including stocks, bonds, government securities and certificates of deposit.
Third, if you own more than one 401(k) account, you could find it advantageous to consolidate them into one IRA, making it easier to allocate and monitor your retirement assets.
Fourth, IRAs may give you greater flexibility if you plan to pass money to your children. In fact, if your child inherits your IRA, he or she can stretch withdrawals over his or her entire lifetime, rather than taking the money as a lump sum. (If you do transfer funds from your old 401(k) to an IRA, use a “direct rollover” to avoid the possibility of triggering unwanted taxes.)
Before making any moves with your 401(k), consult with your tax and financial advisers. By looking closely at your options, and by getting professional guidance, you can make the choice that’s right for you.
Joe Faulk is a financial adviser.