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IRA Rollover Is Important After Job Loss
By Stephen J. Butler

When I've discussed rollover IRAs in past columns, the context was people who were either voluntarily retiring or opting for a lifestyle change. Today, unfortunately, layoffs are forcing many people to deal with their retirement savings long before they had planned to.

During the swarm of emotions you'll experience after losing your job, you'll need level-headed thinking and precise actions to protect the best interests of your retirement assets.

Let's start with the basics. People who get fired often leave retirement money with the former employer under the impression that 1) the money is safe and 2) moving it entails one more decision at a stressful time. In most cases, however, leaving money in a former plan is a mistake.

Why? Well, the fees in the old plan may be substantially more than you would pay in a self-directed IRA. Many plans -- especially those offered by vendors to smaller companies -- pass costs on to participants in the form of higher asset charges that can be as high as 2 percent or more. Avoid these charges by moving to a good financial institution that offers discounted fees and inexpensive no-load funds.

Another factor is the quality of your investment choices, which expands dramatically with your own IRA. You can invest in any stock, bond, or mutual fund sold in the United States. Most employer retirement plans have limited selections for practical reasons, and many of these selections were chosen because of great results prior to 2000.

As a result, there's a scarcity of value-style funds in a typical 401(k) plan. A plan sponsor choosing funds for their plan five years ago would have seen value funds with flat results compared to growth funds with 20 percent or more returns. In one case I am familiar with, employees with a combined total of $3.5 million had chosen the value fund for only $234 of their assets. That value fund was up 24 percent in 2000 while the highly publicized Janus funds, with most of the remaining money, had major losses for last year. In fairness, plan sponsors can't be blamed if they offered diversity that prompted little interest on the part of employees.

But that was then. This is now. Unemployment changes the rules. If your retirement account has suddenly morphed into money needed for living expenses, you may want to move some of it into a money market fund or a short-term bond fund. This will avoid exposure to the next financial jolt.

As a rule of thumb, long-term money is best invested in the stock market. Short-term money that may be needed within five to seven years should be in a fixed-income investment. Following job loss, at least a portion of your long-term objective may have become a short-term objective.

Furthermore, rolling funds to an IRA also avoids the problems that can occur when a stricken company is imploding.

Often, the trustees of a plan are a few senior executives who are out the door with everyone else. The plan becomes a ghost ship with no one at the tiller. The money is safe, but for the time being there is no one to legally disburse it. The directors need to appoint a new trustee, but they may be preoccupied in acrimonious debate regarding the fate of the company and what's left of their investment. Your 401(k) account balance is the least of their concerns.

If you have recently been asked to leave the premises with your personal belongings in a box, the message should be clear. Take a few minutes before leaving to complete whatever paperwork is required to process your distribution. Follow up repeatedly until you see the money appear in your rollover account.

Remember, when you're between jobs, retirement money may be a critical contributor to survival. You can access portions of this money at any time, and the only cost is the 10 percent penalty and regular income tax on the amount you spend. If you are unemployed for a major portion of the calendar year in which you take the distributions, this could be your only taxable income. The tax on the first $20,000 of income for a single person is only about $2,500. The total cost in this hypothetical example, including the penalty, will be $4,500.

Of course, you should weigh this option carefully. It's not a sin to tap your retirement money, but it is a bummer. You are removing money from a program where it could be compounding for years on a tax-deferred basis. Compare this step with other options, such as taking part-time work or borrowing from parents.

Now let's look at rollover mechanics. When filling out your instructions for the distribution, always insist on a direct deposit into your IRA. Never accept a check made out to you personally. A check in your name triggers the 20 percent withholding tax, which might make it impossible for you to deposit the full value of your distribution into a rollover IRA. If 20 percent is withheld, you have to find the 20 percent from somewhere else to make the full deposit. A year later, you may get the 20 percent back, but this doesn't help you during the 60-day period during which you have to deposit your distribution into an IRA to avoid the taxes and penalties. Money sent directly to your IRA avoids this problem entirely. Even if you plan to spend some of the distribution, roll it to the IRA first.

You can always access your money on a moment's notice once it is in the IRA. Reliable vendors have toll-free numbers staffed with well-trained retirement specialists. You control the situation and are not held hostage by circumstances back at your former place of employment.

If you are an older employee with a substantial account balance, the message here is the advantage of better investment choices with control over your costs. Leaving, say, $200,000 in the expensive plan could easily be costing $3,000 in annual fees, (the 1.5 percent cost of many 401(k) investments.) In contrast, a group of good index funds or some bonds in your own IRA might only cost $240 and generate far better results.

What if you are over age 591/2 and still employed, but you think your company may let you go? Consider moving your retirement money to an IRA now, rather than waiting until you leave or retire. This is an option in most plans. As you continue to work, you would continue to make deposits into the company plan, but roll the accumulating amounts periodically into your IRA.

Remember, we have probably five times more money in these plans thanks to tax savings and automatic salary withholding than we otherwise would have had in any after-tax investment program. Knowing that these flexible choices exist should only prompt us to contribute as much as we can possibly afford and then a little bit more. It reminds me of an 85-year-old fellow swimmer, Fred, who said his secret to winning long distance races in his youth was to start by swimming as hard and as fast as he possibly could. "Then," he said, "I would gradually increase my pace."

BUYandHOLD does not offer or provide any investment advice or opinion regarding the nature, potential, value, suitability or profitability of any particular security, portfolio of securities, transaction or investment strategy. Any investment decisions you make will be based solely on your evaluation of your financial circumstances, investment objectives, risk tolerance, and liquidity needs. The securities mentioned above are being used for illustrative purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy and past performance is no guarantee of future results.



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