Handle Your Old 401(k) the Smart Way

Odds are you've had more than one job in your life. If an old employer put some money aside for your retirement, don't just forget about it -- put it to work by investing it the way you want to.

You may think of job-hopping as a recent phenomenon, but it's been going on for quite a while. According to a study by the Bureau of Labor Statistics that ran from 1979 to 2005, baby boomers held an average of 10.5 jobs between ages 18 and 40.

If you've worked for anywhere near that many different employers, it's fairly likely that at least one of them provided you with a retirement plan -- most likely a 401(k) plan. Don't just let that money sit there until you retire. Consider all your options.

Don't just cash that 401(k) money out
Actually, if you've left your old 401(k) accounts alone, you're already doing better than most. According to one study, 45% of all workers simply cash out their 401(k) when they change jobs.

But taking money out of your 401(k) is a big mistake. You'll immediately owe taxes on the money you withdraw, along with a 10% penalty in most cases. More importantly, you'll miss out on the opportunity for decades of tax-deferred growth on your investments, decades that can turn relatively modest amounts into surprisingly large sums of money.

Leaving your 401(k) investments alone
So if cashing out your 401(k) is a mistake, should you just leave it alone at your former employer? That's a viable option in many cases, but there are a couple of things you should watch out for.

Many 401(k) plans charge fees and other costs that make them relatively expensive. So expensive, in fact, that many companies have gotten sued by employees. Companies facing lawsuits include Wal-Mart (NYSE: WMT), General Motors (NYSE: GM), Deere (NYSE: DE), and Exelon (NYSE: EXC).

In addition, the financial companies that sponsor such plans have come under scrutiny. Specifically, lawyers are investigating plan sponsors that offer variable annuities within 401(k) plans, including firms like AIG (NYSE: AIG), Prudential (NYSE: PRU), and MetLife (NYSE: MET).

As a plan participant, you don't want to get involved with all that litigation, especially if you have only a small amount in the plan. Fortunately, there's an easy way out that makes a lot of sense for most people.

Roll those 401(k) accounts over!
Once you've left your job, you can move your 401(k) account money into your own IRA. The tax laws call this a rollover, and it opens up a huge range of choices.

Within a 401(k), you're pretty much stuck with the investment options your employer gives you, even if they're lousy. An IRA, on the other hand, has almost limitless choices on how you can invest. You can open an IRA with a broker, mutual fund company, or other financial institution, giving you access to nearly any type of investment. If you need to open a new account, you can look at several choices right here with our broker comparison chart.

In addition, you can now rollover a 401(k) directly to a Roth IRA. Although you'll pay tax as if it were a Roth conversion, all your future earnings will be tax-free.

There are a few situations where it might make sense to keep your 401(k). For instance, some plans let you take penalty-free distributions at age 55, whereas an IRA imposes penalties until you're 59 1/2. In addition, if you own employer stock that you want to hang onto, you may not be able to transfer it out of your 401(k), especially if the stock isn't publicly traded.

Usually, though, if you've got an old retirement account with a former employer, the smart thing is to go ahead and roll it over. The flexibility, cost savings, and tax benefits will make you glad you did.

For more on managing your retirement money, read about:

• Why you can't stop investing toward retirement even in a down market.
• How you can retire rich.
• Nine things that can kill your retirement.