When you leave your job—whether you're laid off, find a better job with a different company, or quit to go back to school or start a business—you have to make a decision about what to do with the money you've accumulated in your 401(k) or 403(b) retirement plan. Many people don't know they have choices. Here are some options on what you can do with old retirement investment accounts:
Roll your 401(k) into a self-directed individual retirement account (IRA). This choice is usually the best move because you'll have more control over your investments. Like a 401(k), a self-directed IRA is a tax-deferred account. However, most IRA providers offer an unlimited number of investment choices, rather than the small list of funds an employer provides. So if your situation changes, you'll be able to choose any investment that's best suited for your needs. In addition, if you want help from a financial adviser, you can choose any adviser rather than being restricted to services offered by the 401(k) plan.
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If you still have a few retirement plan accounts at former employers, those can be consolidated into one self-directed IRA. Any qualified retirement plan assets can be moved into the same IRA without a tax hit when you leave your job in the future. In the end, transferring your 401(k) into an IRA makes the most financial sense.
Leave the money behind. You can keep your 401(k) with your former employer without getting hit with taxes or penalties. Most 401(k) plans limit the number of funds you can choose from, so leaving your money behind perpetuates the problem of having limited investment choices.
Plus, when you leave your job, you might not be eligible for any financial advisory services offered by the company. This means that your 401(k) assets will probably not be managed, so as time goes on, you may not own the right mix of investments as your goals and needs change.
Roll your 401(k) into your new employer's retirement plan. You'll probably encounter the same problems as the previous choice, because your new employer's 401(k) plan is also likely to offer a limited number of investment choices.
Also, once you roll over your money into the new 401(k), you can't undo it. Your money has to stay with your new employer's retirement plan until you leave the company. But at least you preserve the tax-free status of your retirement money.
Take your 401(k) money in cash. If you cash out your 401(k) plan, you'll have to pay taxes. If you're under age 59 1/2, you'll also have to pay a 10 percent early withdrawal penalty. As a result, you would lose close to half of your 401(k) money to the penalty and taxes. In addition, your retirement money will not be compounding any more. For these reasons, cashing out is a terrible idea.
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Despite the costs, a majority of people take the cash. According to a 2010 study by Hewitt Associates, 46 percent of employees took a cash distribution from their 401(k) plan when they left a company. I understand the allure of cashing a check for thousands of dollars, but it has a terrible impact on your retirement savings. Think twice before doing so.
Adam Bold is the founder of The Mutual Fund Store, which provides fee-only investment advice with locations coast to coast. He's also host of The Mutual Fund Show, a call-in radio program broadcast across the country. Bold is author of the book The Bold Truth about Investing (April 2009). Bold is Chief Investment Officer of The Mutual Fund Research Center, an SEC-registered investment adviser, which provides mutual fund and asset allocation recommendations, and research to stores in The Mutual Fund Store system.