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What to do with my 401(k)?
I'm retiring; what I should do with my 401(k)? Should I pull it out, put it in my bank, or what?
March 2, 2004: 2:38 PM EST
By Walter Updegrave, CNN/Money contributing columnist

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NEW YORK (CNN/Money) - I'm retiring in three months and I'm unsure what I should do with my 401(k). Should I pull it out in a lump sum, put it in my bank, or what?

-- Juan Davila, San Antonio, Texas

It brings out the Elvis in me when I hear anyone suggesting that they'll pull out their 401(k) in a lump sum -- that is, I get all shook up.

I don't know whether you realize it or not, but if you simply have your employer mail you a check for the balance of your 401(k) and you begin spending that money or even put it into a regular bank or investment account, you would owe ordinary income taxes on the whole shebang. Depending on the size of your 401(k) and other income you might have, you could end up turning up to 35 percent of your balance to the IRS.

In fact, if you're under 55 when you retire from your company, you would also owe a 10 percent penalty in addition to regular tax. Just thinking about that kind of hit gets my "brain a'flamin," to paraphrase the King's word's in his 1972 hit, "Burning Love."

Avoid the tax-man

Fortunately, you can avoid this situation very easily. Basically, you want to preserve the tax-deferred status of your 401(k) stash, and there are two alternatives when it comes to doing that.

First, you could simply leave your 401(k) money with your employer, if your 401(k) plan allows this option. In that case, your stash would remain in whatever investments you've chosen and it would continue to grow free of taxes.

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I don't think this is an ideal choice for several reasons, though. For one thing, companies really run 401(k) plans for the benefit of current employees, not retirees. They're probably not used to dealing with retirees and, indeed, may consider it a bit of a drag to have to deal with you at all.

Equally important, company 401(k) plans are really set up for accumulating money, not paying it out on a regular basis. So if you're planning on making regular withdrawals from your 401(k) for retirement living expenses, getting your money out on a timely and regular basis could be a hassle.

Your second choice -- and, I think, clearly the better one in most cases -- is to transfer your money to an IRA rollover account. By doing this, your money continues to grow without the drag of taxes as long as it remains in the account -- plus you have much easier access to it for withdrawals.

In doing this rollover, you want to be sure to do what's known as a direct or trustee-to-trustee transfer from your 401(k) to the IRA rollover account. You could have your employer cut a check to you, after which you'd have 60 days to deposit the funds in an IRA rollover.

But if you do that, your employer will withhold 20 percent of the value of your account, and you'll have to make up the difference out of your own pocket to do the rollover. You would get your 20 percent back when you file your income taxes. If you can't cover the difference, any amount you don't rollover would be considered a taxable distribution. So to avoid this hassle, do a direct rollover.

Where to rollover?

Now, as to the question of where to open your IRA rollover, I think the main consideration is what institution is going to offer the range of investment choices and other services you may need.

You're going to want to build a diversified portfolio that includes stocks (or stock mutual funds), bonds (or bond mutual funds) and cash (money market funds, CDs and the like). You don't have to keep all your IRA money in one place -- you could rollover your balance to one institution and then roll over a piece of it to another -- but keeping your stash together certainly makes it easier to invest and monitor.

So if I were you, I'd look for an institution that offers a broad range of mutual funds and, possibly, other investments. Most large mutual fund companies fit that bill, as do many large brokerage firms and even some banks; indeed, many offer the option of investing not just in their own funds but in those of their competitors.

I'd take particular care to search for an institution that doesn't go overboard on fees, since every buck you pay in expenses lowers what's available for you. While there's no Web site that I know of that allows you to compare all different types of institutions by their fees, you can check out the annual expenses and sales charges on virtually all mutual funds by going to the Fund section of Morningstar.com.

But the most important thing of all is that you preserve the tax-deferred status of your 401(k) nest egg so that the money that remains in the account gets the benefit of tax-deferred compounding. Screw up on that step, and you may find yourself living your golden years at the Heartbreak Hotel.


Walter Updegrave is a senior editor at MONEY Magazine and is the author of "Investing for the Financially Challenged." He also answers viewers' questions on CNNfn's Money & Markets at 4:40 PM on Mondays.  Top of page




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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.