Personal Business: Smart Money
HOW TO TAKE YOUR 401(k) ON THE ROAD
In this time of uncertain job futures, an advantage of 401(k) plans is that you can take them with you. But you have to transport your nest egg with care to avoid penalties and keep your options open. There are essentially three choices: roll over your old 401(k) into a similar plan at your new job, transfer it into an individual retirement account, or leave it with your former employer. If you decide to move the money, the most important step is to file forms to make a "trustee-to-trustee" transfer.
As long as the 401(k) goes directly from your old plan to your new one or to the bank or brokerage that has your IRA, you're safe. But if the company you're leaving gives you the check, it will withhold 20% of your savings for the Internal Revenue Service. Then you'll have to make up that 20% so you can transfer the whole amount to the new plan. If you can't make up the shortfall, you'll be taxed on the 20% that was withheld--and liable for an extra 10% penalty if you're under age 591/2. But if you move the entire amount within 60 days, you can file for a refund of the withheld funds on your next tax return.
When you switch jobs, most companies with 401(k)s will accept your money right away. But some require you to work for a year before they will take the funds or let you contribute. Others may not allow transfers even if they have a 401(k). In that case, you can leave your balance with your old company or roll it into an IRA. All employers are required by law to keep the 401(k)s of former employees until retirement or age 62 if there's at least $3,500 invested. You can't make tax-deductible contributions after you leave, but the money will continue to grow tax-deferred. And because it's in a large pool, you sometimes have access to better money managers and more attractive investments than you could afford on your own.
But there are compelling reasons to take the money and run. Some companies will limit your investment options after you depart--you may no longer be able to buy company stock or certain funds. Or too much of the money in your old plan may be tied up in company stock. Switching to a new plan gives you a chance to cash out and diversify. Ask yourself if "the investment choices in the new plan are at least as good if not better than the choices you're leaving," advises Kevin Roach, a partner at Price Waterhouse. If the choices are similar, take the money with you.
If you can't transfer your plan and don't want to leave it with your former employer, you can roll it over into a "conduit" IRA. This must be a new account set up to hold only your 401(k) funds. As long as they're not mixed with any other monies, your nest egg can reside in the IRA indefinitely and still be rolled back into a 401(k) plan in the future. This is a good ploy if you're starting your own business; later you can transfer the funds to a Keogh or simplified employee pension. Since you may not have these plans set up for a while, a conduit IRA comes in handy, says Martin Nissenbaum, a partner at Ernst & Young.
To keep your options open, don't transfer 401(k) funds into an existing IRA. If they aren't separate from other money, you can't roll them back into a 401(k). And without a 401(k), you lose the benefit of using five-year forward-averaging to withdraw funds at retirement. This option gives you a tax break when you want to withdraw your entire balance. Lump sums are "most compelling if you have short-term need for the capital," says Roach. Say you need the $100,000 from your plan to buy a condo in Florida. Divide the $100,000 by five. The resulting $20,000 is treated legally as if it were your only income. So your $20,000 is taxed at 15%, for a bill of $3,000. You then multiply $3,000 by five, for a total tax bite of $15,000. If you had paid a straight tax on the $100,000, your bracket would be at least 31%, and your bill, $31,000. Lump sums above $750,000 are hit with a 15% excise tax, so the benefits of five-year averaging decline as withdrawals grow much above that amount.
SILVER LINING. Even if you're just considering job-hopping, avoid taking a 401(k) loan. Some companies let you borrow funds without paying taxes from your plan, usually up to $50,000 or half of your vested funds. Then you gradually pay yourself back. But if you leave for another job, any outstanding loan amount will be considered a distribution. It will be taxed as ordinary income--and you'll pay the 10% penalty if you're under 59 1/2.
One silver lining behind all these cautionary clouds: If you switch jobs and you're at least 55, you can cash out of your existing 401(k) without incurring a penalty. Current tax law requires only that you leave your company to collect, not that you actually retire. Sometimes, age does have its rewards.
When You Change Jobs
-- Move the funds to your new employer's 401(k) plan, but be sure to make a "trustee-to-trustee" transfer to avoid tax penalties.
-- Leave your money at your old job until retirement if you prefer its investment choices or if your new company won't accept your plan.
-- If you can't bring your nest egg to your new job or are starting a business, set up a "conduit IRA," totally separate from other funds.
DATA: BUSINESS WEEKPam Black