Unexpected job loss can derail retirement plans in an instant. American employers shed 524,000 jobs in December, and 31 percent of employed adults ages 45 and up think it's likely that their job will be eliminated this year, according to a recent AARP survey. The good news is that if you do get laid off, you can still keep your retirement plan intact. Here's how to handle your 401(k) if you lose your job or your company goes under:
Find out if you're vested. Any money that goes into your 401(k) is yours, even if your company folds. However, employer contributions must be vested before they're permanently yours. About 44 percent of 401(k) plans provide immediate vesting for matching contributions, according to the Profit Sharing/401(k) Council of America, which means you get to keep your employer's match as soon as it's deposited. Other plans require you to be with the company two or three years before you can keep your employer match. And some companies impose a graduated vesting schedule in which you can keep a gradually increasing percentage of your employer's contributions, based on your job tenure.
Decide whether to move it. If you want to maintain the tax-deferred benefits of your 401(k) money, you have three choices: leave the money in your old employer's plan, roll it over into another tax-deferred format such as an individual retirement account, or, when you get a new job, transfer it into your new 401(k). IRA rollovers are a wise move for retirement savers if the IRA charges lower fees than the 401(k) plan. "If someone is in retail mutual funds in their 401(k) and can roll over their 401(k) into an index fund at a low-cost fund provider, it's a great opportunity to get better quality and lower-cost funds," says Matthew Hutcheson, an independent pension fiduciary.
It's worth noting that large companies often negotiate institutionally priced investments with lower costs than individuals can get on their own from retail IRAs. "If you're with a large employer, they generally have some type of economy of scale, and sometimes the employer subsidizes some of the costs of the plan and can spread costs over many people," says Craig Copeland, a senior research associate at the Employee Benefit Research Institute. If your 401(k) has lower fees and cheaper investment options than the IRA, it makes sense to stay put.
Look for investment deals. Your 401(k) has a limited selection of investments, which are vetted by your employer or plan sponsor. Some plans offer a small menu of choices, so investors looking for more options might enjoy the freedom of an IRA. When it comes to IRAs, in general, "you get a lot more investment choices than you would in a 401(k) plan," says Howard Hook, a financial planner with Access Wealth Planning in Roseland, N.J. Savvy investors may even be able to bag some good deals. Hutcheson thinks low-cost, broad-market index funds are a good bet, since "you can buy lots of shares, and when the market starts to appreciate, you are going to get a significant upside."
Roll it over directly. If you decide to roll over your retirement account, it's a good idea to have your plan sponsor wire the money directly to the new financial custodian. Be aware that if you take your 401(k) in a lump sum, your employer will withhold 20 percent for income taxes in case you decide to cash out and keep the money. Generally, you have 60 days to move the money to another tax-deferred account. If you don't meet that deadline, Uncle Sam keeps the 20 percent, plus any additional amount you owe at tax time. And if you're under age 55, you'll also get hit with a 10 percent penalty.
Try not to cash out. Raiding your retirement stash robs you of compounding interest. Hutcheson puts it this way: "Any dollar you take out of your account today, you are taking about $3 away from your future self." You'll also have to pay income tax on any withdrawals, and if you're younger than 55, you'll be hit with a 10 percent penalty. If you roll your 401(k) into an IRA, the early withdrawal penalty lasts until age 59½. So, if you're between 55 and 59 and think you might need to tap your nest egg, it might make sense to stick with a 401(k). Another thing to consider is that 401(k)'s are protected from your employer's creditors as well as your own creditors, says Hutcheson. The same protection doesn't apply to IRAs.