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Losing Your Job? What About Your Retirement Account?
By Stephen J. Butler |
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People leaving jobs often leave their retirement money back with their former employer. The thinking is that the money is safe and moving it entails one more decision at an otherwise stressful time. In most cases, however, leaving money in a former plan can be a mistake.
First, the fees in the old plan may be substantially more than you would pay after rolling the money over into a rollover IRA. Many plans, especially those offered by vendors to smaller companies, pass costs on to participants in the form of higher asset charges. They can be as high as 2% or more. In the past year of mutual fund losses, this just adds insult to injury. Avoid these charges by moving to a good financial institution that offers discounted fees or inexpensive no-load funds.
The quality of your investment choices expands dramatically if you move to your own IRA. You can invest in any stock, bond, or mutual fund sold in the U.S. Most retirement plans have limited selections for practical reasons, and many of these selections were chosen originally because of great results over the years prior to 2000. As a result, there are not that many value-styled 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% 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 fund was up 24% in 2000 while the ever-popular Janus funds, with most of the remaining money, had major losses for last year. 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. If your retirement account has suddenly morphed into money you now have to use 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. Getting back to the basics, you'll recall that long-term money was 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. Suddenly, at least a portion of your long-term objective may have become a short-term objective.
Rolling funds to an IRA also avoids the mechanical problem that can occur when a 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 like 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 are one of those people who 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, your 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% penalty and regular income tax on the amount you spend. If you are unemployed for a major portion of the year in which you take the distributions, this could be the only income you have that will be subject to taxation. The tax on the first $20,000 of income for a single person is only about $2,500. The total cost, including the penalty, will be $4,500.
So, if you are headed back to college or graduate school for a year or more, this may be the only income you have. If you want to take time to find the perfect next job, your retirement money may provide you with that luxury.
It's not a sin to tap your retirement money, but it is a bummer. It is very expensive to remove money from a program where it could be compounding for years on a tax-deferred basis, so the need to do this should be weighed very carefully.
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. This triggers the 20% tax withholding which might otherwise make it impossible for you to deposit the full value of your distribution into a rollover IRA. If 20% is withheld, you would have to find the 20% from somewhere else to make the full deposit. A year later, you may get the 20% 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. Therefore, even if you plan to spend some of the distribution, it makes sense to roll it to the IRA first.
You can always access your money on a moment's notice once it is in the IRA. You control the situation and you 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 more on the advantage of better investment choices with control over your costs. Leaving, say, $200,000 in the wrong expensive plan could easily be costing $3,000 in annual fees, (the 1.5% cost of many 401(k) investments.) Instead, some good index funds or some bonds in your own IRA might only be costing $240 and generating far better results.
What if you are over age 59 and one half and still employed but you think your company may have a reason to let you go? You might consider moving your retirement money to an IRA now, rather than waiting until you leave or retire. This is an option in most plans, and you would consider this step for all the reasons cited above. As you continue to work, you would continue to make deposits into the company plan, but roll the accumulating amounts periodically into your IRA.
What this column should illustrate is the extent to which we need to "work the system" to accomplish what is in our best interests. There are possible applications of pension and tax rules that we have to weigh in the light of our own specific situations. Pension laws protect retirement accounts, but real events may make them inaccessible (and therefore as good as lost if desperately needed) Retirement money we choose to spend will trigger taxes and possibly penalties, but that may be acceptable in a year when other income is reduced or non-existent.
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 continue contributing as much as we can possibly afford...and then a little bit more. The "little bit more" may be far more valuable as spending money in the future than the marginal enjoyment we gain from it today.
The securities markets are subject to the risks of fluctuating prices and the uncertainty of rates of return and yields inherent in investing and past performance is no guarantee of future results.
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