epending on what report or poll you refer to, the average American seems to change jobs somewhere between 5 and 12 times in their lifetime. No matter where you fall in this broad range, if you are changing jobs or retiring, it’s important to determine what to do with your 401k or other retirement plan.
There are basically four things you can do with your retirement plan balance when you leave an employer. Cash it out and spend it, leave it with your previous employer, roll it over to your new employer’s retirement plan (if the new plan allows it), or roll it over to a self directed IRA. The least desirable is to cash it out. Depending on your age, there may be a 10% penalty to do so and regardless of your age, you will pay ordinary income tax on the amount you take out. Even worse than the taxes, this strategy will reduce what you will have to spend when you retire. Leaving it behind is another option. I come across many people that just leave their money in their old retirement plan when they change jobs or retire. This is certainly better than cashing out but may still not be ideal. A couple of problems that may arise from this strategy are; you may lose track over the years of how a particular plan fits into your overall retirement strategy. How much do you love changing your retirement plan asset allocations to keep your investments aligned with your goals right now? How many of you think it’s too much of a hassle and don’t rebalance your retirement plan investments like you should choosing instead to ignore the statements month in and month out? (Guilty) Multiply this headache by however many plans you have floating around and you will begin to see the wisdom in bringing your retirement plan with you when you leave a job or retire. In addition to forgetting to rebalance your portfolio, it’s also easy not to keep your beneficiary information up to date over the years and as I mentioned in a previous article, this could cause big problems for your family down the road.
If you are changing jobs and your new employer has a retirement plan, you may want to check to see if the new plan will allow a transfer of the balance from your old plan into the new one. By the way thanks to the Tax Relief and Reconciliation Act of 2001, it is much more likely you will be able to do this. I think this strategy is the best so far because it will keep all of your retirement plan assets in one place making housekeeping issues like portfolio rebalancing and updating beneficiary information a little easier. The biggest drawbacks to this strategy are; you are limited to the investment choices available in the new plan and you are subject to the rules of the new plan, i.e. loan and withdrawal limitations, frequency of changes to investments, etc. This brings us to the final choice. Rolling your retirement plan into a self directed IRA. Note, if you are retiring, this may be the best option for you to consider.
Rolling your retirement plan into a self-directed IRA can offer you more investment options to avoid any current income tax and maintains the tax deferred status of your retirement assets. Once your retirement account is converted to a self-directed IRA, you may consider converting all or part of the account to a Roth IRA. This will be a taxable event, but once converted to a Roth IRA, your money will grow tax deferred and at retirement will offer tax free distributions unlike a traditional IRA or converted 401k.
This strategy should only be considered after consulting a tax professional but, could potentially be a significant advantage when you retire and start to draw money from you retirement accounts. One last thing to be aware of is any outstanding loan
balances on your retirement account when you change jobs or retire. Unless you pay these off before you complete a rollover to a new retirement plan or self directed IRA, your tax free loan will become taxable distribution.
Since there are very few do-over’s when it comes to retirement planning, deciding what to do with an old retirement plan balance needs to be thoroughly evaluated and discussed with your tax and financial advisor.
(Editor’s Note: Chad M. Winn is a financial advisor for Wells Fargo. Email Chad at firstname.lastname@example.org, or call 584-3017.)