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401(k) rollovers and you
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October 7, 1999: 6:29 a.m. ET
When -- and when not -- to leave your plan in your ex-employer's account
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NEW YORK (CNNfn) - It's no secret the American work force has developed a penchant for job-hopping.
The Bureau of Labor Statistics reports the average U.S. citizen will hold 8.6 different jobs -- between the ages of 18 and 32 alone.
That may be good career strategy in today's go-go job market, but experts say it also has sparked a good deal of confusion over what should be done with the 401(k) plans workers leave behind.
Should you let it ride in your former employer's account, roll it over to an individual retirement account (IRA) or take the money and run?
The answer, says certified financial planner Dale Boushley, is "it depends."
"If a client comes in with a 401(k) plan that's eligible to be left behind, my first inclination is to look at what investment choices the former employer is offering," he said. "If the company still offers you reasonable options then it's not a bad idea to leave them behind."
A disincentive
For starters, let's be clear: If you have more than $5,000 in your 401(k) plan, your former employer cannot legally force you to remove your balance from their account.
But that doesn't mean the company can't make it unpleasant for you.
Some companies severely restrict the number of investment funds available to ex-employees. Some only allow your 401(k) to remain invested in low risk, low-return funds, and others prevent plan participants no longer on the payroll from making any changes to their 401(k) plan whatsoever.
You should find out which restrictions apply -- if any -- before making any hard-and-fast decisions about your plan.
"It's funny how each employer takes a different twist on how friendly they want to be," Boushley said, noting some plan sponsors won't allow former employees to take partial distributions. "It can be an all-or-nothing rule."
Lastly, if you do decide to leave your 401(k) plan behind, be aware that you'll no longer be able to contribute to it and, of course, your former boss won't be dumping any money in there either.
Flexibility
Unless you're faced with a financial crisis, experts agree you should not consider cashing out of your 401(k), or taking a distribution, as an option.
Not only will the Internal Revenue Service tax your withdrawal as regular income, but if you're under age 59-1/2 you'll get hit with a extra 10 percent penalty.
Also, you'll be cheating yourself of the compounded returns you otherwise would have earned -- money that could have a profound effect on your standard of living after retirement.
By waiting to withdraw until after you retire, you'll take home substantially more of your hard-earned dollars since you'll avoid the penalty and your tax bracket -- in most cases -- will have dropped as well.
It should be noted that if you absolutely need it, there are still a few ways to withdraw that money early with tax implications but without paying a penalty.
Susan Rogers, an enrolled agent, certified financial planner and spokeswoman for the National Association of Enrolled Agents, said you can use the funds to finance your college tuition, to purchase your first home, or to make up for lost wages in the event you become disabled.
Moreover, she said, you can tap into your 401(k) plan early if you agree to take the money out in equal payments over at least a 5-year period.
"If you are 45, your investments have done well and you are looking to retire, you can go ahead and set a distribution play," Rogers said. "All you have to do is follow the actuarial tables and take out the appropriate distributions."
For some, this can help you avoid another problem as well.
"A lot of people these days, ironically, have accumulated so much money in their 401(k)s that they have ended up in higher tax brackets when they retire than they did while they were working," Rogers said.
By taking regular distributions from your 401(k) early, she said, you can even things out on your income tax form.
Check with your financial planner before taking this step.
Your options
After you've left a job, you usually have the option of transferring your 401(k) balance into your new employer's account.
Keep in mind, though, that many companies won't allow you to begin contributing to it right away and a few won't allow you to move the money into their accounts at all until you're eligible to contribute.
By far, the dilemma facing most job hoppers today is whether to leave the money where it is or roll it over into a self-directed individual retirement account, or IRA.
David Mellem, an enrolled tax agent and research manager for the National Association of Tax Practitioners, said that decision should largely be based on whether you think you'll want access to that money before you retire.
Again, early withdrawals are only advisable if you've already saved up enough to finance your Golden Years or as a last resort.
"If you want to take the money out before you turn 59-1/2, you probably want to roll it over into an IRA," Mellem said.
That's because the rules governing 401(k) plan distributions are highly restrictive.
"With 401(k)s the money can only be withdrawn when you retire, leave the company, die, become disabled, or experience an extreme financial hardship," Mellem said. "You can't just take out the money for a cruise around the world."
In an IRA, you can generally pull your money out in 7 to 10 business days. You'll still have to pay the taxes -- and penalties if you're under age 59-12 -- on a distribution, but you will have access to those funds.
Reasons to leave it
Like most tax practitioners, Mellem said each situation is different when it comes to 401(k) rollovers.
One reason you might opt to leave your plan where it is, though, is if it's invested in a mutual fund that is now closed to new investors, he said.
Also, if you've made any after-tax contributions it's probably wise to leave it behind as well - since you can't roll that money over anyway.
Same goes if your former employer's 401(k) is fee-free, since an IRA will often charge you an annual administrative fee for smaller accounts -- usually less than $50 a year.
Reasons to leave
By and large though, Rogers said she believes it's a good idea to take your 401(k) plans with you when you leave a company because of the restrictions you otherwise would face.
"If you decide to leave it behind, you will have to follow whatever their rules are and you may be limited on the choice of your funds," she said. "That's OK in some situations, but you have to recognize that this is still a limitation."
She noted: "I have a tendency to recommend to my clients that when they leave a company they should roll it over to a self-directed IRA so they have control over where they invest and when they can get their distributions."
The call for consolidation
Lastly, if you've got several 401(k) plans sitting in the accounts of former employers, Boushley said you should also look at how much, if anything, your former employers are charging you in annual fees to leave them there.
"It's like having $50,000 in six different banks," he said. "There's no advantage to that. If you gather it into one place you can usually get a no-fee account, since the dollar amount is higher, instead of getting hit with fees from each separate account."
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