Leaving your job? Roll Your 401(k)

12:40 PM, Jun 10, 2009   |    comments
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By SANDRA BLOCK

USA TODAY

Most employees leave their jobs with a box full of keepsakes: company awards, coffee mugs, maybe a photo of the boss wearing a lampshade on his head. But here's something many departing employees leave behind: their 401(k) plans.

 

More than 40 percent of assets in 401(k) plans owned by workers who left their jobs in the first quarter of 2008 were still with their former employers a year later, according to a recent analysis by Charles Schwab. The remaining assets were invested in an individual retirement account, rolled into a new employer's plan, or cashed out.

 

Leaving your 401(k) with your former employer is vastly better than cashing it out, which will trigger taxes, and if you're under 59½, early-withdrawal penalties.

 

But IRAs offer numerous advantages not typically available to 401(k) owners. Here are five reasons you should consider rolling your money into an IRA:

You're unemployed and need to buy health insurance.

If you're out of work, you can take penalty-free withdrawals from your IRA to pay the premiums. To qualify, you generally must have received unemployment benefits for at least 12 consecutive weeks. The rule also applies to premiums paid under COBRA, a federal law that allows you to continue your former employer's coverage for up to 18 months, says Bob Scharin, senior tax analyst for Thomson Reuters.

 

You're considering buying a home.

If you're a first-time home buyer, you can withdraw up to $10,000 penalty-free from your IRA to put toward the purchase of a principal residence. Even if you've owned a home in the past, you may qualify: The law defines a "first-time home buyer" as someone who hasn't owned a principal residence in the two years prior to the home purchase.

 

You need money for college.

You can take penalty-free withdrawals from an IRA to pay college expenses for you, your spouse, your children, or your grandchildren.

None of these penalty-free withdrawals are available if you leave your money in a former employer's 401(k) plan, says Catherine Golladay, vice president for 401(k) advice and education at Charles Schwab.

You're considering taking early retirement.

 

Ordinarily, if you take withdrawals from your tax-deferred retirement savings before age 59½, you have to pay a 10 percent penalty. You can avoid this penalty, however, by taking advantage of the "substantially equal periodic payments" rule. This rule allows you to avoid the early-withdrawal penalty as long as you agree to withdraw a specific amount of money for five years or until you turn 59½, whichever is longer. You'll still owe income taxes on your withdrawals.

 

Legally, there's no prohibition against taking periodic payments from a former employer's 401(k), but some plans limit the types of distributions you can take. You won't run into this problem if you roll your money into an IRA.

There is an important caveat for early retirees. If you're 55 or older when you leave your job, you're eligible to take penalty-free withdrawals from your former employer's 401(k) plan. This option isn't available if you roll the money over to an IRA, Scharin says.

 

Keep in mind, though, that this exception is limited to workers who are at least 55 when they leave their jobs. If you retire at 54, you're not eligible, even if you wait until you're 55 to withdraw the money.

You'll have more investment choices.

 

Rolling your money into an IRA will provide a greater variety of investment options, along with investment tools and advice, Golladay says. If you change jobs several times, rolling over your 401(k) plans to an IRA will also allow you to consolidate all your savings in one place.

 

Another alternative is to roll your savings into your new employer's plan, assuming the plan allows rollovers. Check out your new employer's investment lineup first. You probably won't have as many choices as you would in an IRA, but some 401(k) plans offer low-cost institutional funds that are only available in employer-sponsored retirement plans.

 

The biggest downside to leaving your money in your former employer's plan is that you're more likely to forget about it. After a few years, that could lead to a portfolio that's as unbalanced as your former boss. And at a time when traditional pensions are fast disappearing, most of us can't afford to neglect our retirement savings, Golladay says. When it comes to your 401(k) plan, she says, "Out of sight, out of mind is the worst scenario."

 

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