Inside Track: Have 401k, will travel

by Stephanie Sanborn

April 2, 2001 —

BECAUSE 401Ks are often a cornerstone of retirement plans, workers switching jobs should make sure that their funds continue to provide the most benefit and bang for their buck, says Dave Braze, personal finance and retirement planning specialist for The Motley Fool, in Alexandria, Va.

Option 1: Leaving it with former employer

If you have more than $5,000 in your 401k, the law states that you can leave the funds in your former employer's plan until you reach the "normal retirement age" as defined by that plan.

"If you're satisfied with the investments that that 401k plan has, it's probably OK [to leave it with the former company], provided the costs of those investments are lower than you can get somewhere else, [which is] not likely," Braze says. If you have less than $5,000 in your 401k, however, a company will likely force you to take your funds when you leave, he adds.

Option 2: Transferring it to new company's plan

Moving existing funds into a 401k offered by your new employer can be a good way to ensure that your retirement fund continues to earn interest. But before making such a move, workers should take a close look at the parameters of their new company's 401k plan. Most will have a waiting period before a new employee can join the 401k plan, preventing the automatic transfer of old funds.

Negotiating to skip a 401k waiting period may be tough if not nearly impossible. Braze notes that some plans have rules dictating that money will not be accepted from employees' former plans at all.

Option3: Transferring it into an IRA

An IRA can be one of the most secure places to put 401k funds because it continues to compound, tax-deferred, Braze says. In addition, almost all states provide protection for an IRA from the holder's personal bankruptcy.

Moving an existing 401k into an IRA can be done using direct account-to-account transfer or by rollover where the employee actually receives a check that must be deposited into an IRA within 60 days. Braze considers direct transfer to be a better choice than rollover.

"In a rollover, automatically by law the plan must withhold 20 percent of whatever it's distributing from that plan. So if you had $100,000 in your 401k, $20,000 would immediately be taken out for withholding and sent to the IRS, just like your paycheck," Braze explains. "But if you don't come up with that missing $20,000 from other assets and all you put in your IRA is the $80,000, you have not made a complete rollover. The IRS will call that $20,000 a distribution to you, even though you never saw it and they've got the money. They will tax you on that $20,000, and if you're younger than 59 and a half years old, they'll slap that 10 percent early withdrawal penallty on you on top of it. That's a big penalty to pay."

Regardless of the transfer method, 401k funds can only be put into a traditional IRA; only funds from another Roth account or a traditional IRA can be transferred to a Roth IRA.

Option 4: Cashing out

Of course, there is always the option of cashing out a 401k when leaving a company, but taking the money out and not reinvesting it in another way negates any chance of it earning any more for your retirement. Pressures to pay bills or take care of major expenses causes some people to cash out small 401ks, small being under $50,000, Braze says. "If they [cash out] and they're under 59 1/2, they can lose up to 42 percent of [the funds], easy. They will be penalized and taxed by both IRS and state."

Don't be afraid of layoffs or market hiccups

401k funds will generally stay secure if an employee is laid off or if his or her company goes under because they are held by an independent custodian and the money is already in the fund. But Braze suggests that, if a company crumbles and layoffs ensue, workers should make sure their 401k is invested at a level they are comfortable with, considering market fluctuations at the time.

Even workers who are secure in their jobs should think about diversifying if they have more than 10 percent of a fund in their company's stock. This is especially important for tech workers to remember, Braze adds, as technology companies are more likely "to use company stock for 401ks because it is the cheapest thing for the company to do, and that creates a problem for the employee -- they aren't diversified enough," Braze says.

Market rumblings should definitely not be cause for a frantic rush to change 401k funds. "As a matter of fact, that's the worst reason to [make changes]," Braze says. "If they've got longer than 10 years or so until retirement and they're in stocks and worried about it, they shouldn't be, based on history, because the stock market will recover," Braze advises. "If it doesn't, the whole world's going down the tubes, and we've got much bigger problems to worry about."

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