Rollover Is Important After Job Loss
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.
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
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.
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
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.
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.
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
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.
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."
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