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The Worst Thing to Do With Your 401(k)

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Whenever you change jobs, there are several details that need tending -- for example, ensuring continued health coverage, packing your belongings, and cleaning your computer of non-job-related and embarrassing files and Web addresses.

Add to that list another important task: Taking care of the assets in your former employer's retirement plan. You have several choices:

1. Leave the money: The old plan might allow you to continue to participate. It's still your money, although you will lose any employee benefits such as matched contributions. Take this option only if you are very pleased with the investment choices and low fees offered in the plan.

2. Take the money and go on vacation: You could just ask for a check and go see the castles of Europe (or, if you have a more typical balance, the McDonald's on Main Street). However, the withdrawn earnings and previously untaxed contributions will count as ordinary income and will be taxed as such. And, if you're younger than 59 1/2, you'll pay a 10% penalty. So if you had $10,000 in your 401(k), you might end up with just $6,000 or less after taxes and penalties, depending on your tax bracket. Plus, you've compromised your retirement nest egg.

Despite these obvious drawbacks, a study by Hewitt Associates (NYSE: HEW  ) found that 46% of people who change jobs cash out their 401(k)s. You really don't want to be one of them.

3. Transfer the money to your new employer's plan: This may simplify things because it keeps you from having a bunch of retirement accounts. But that simplicity isn't worth it if the choices in the new plan are mediocre and the fees excessive (as are most of the choices in employer-sponsored retirement plans).

4. Transfer the money to an IRA: This is the Fool's favorite. With the money in an IRA, you will have much more flexibility. Instead of being limited to the handful of ho-hum mutual funds offered in most retirement plans, an IRA with a discount broker would allow you to buy all sorts of investments. Want to invest in bonds? Some brokers let you span the fixed-income universe, ranging from highly rated issuers like Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) to risky high-yield junk debt issued by companies such as Ford Motor (NYSE: F  ) . In addition, real estate investment trusts such as Vornado Realty (NYSE: VNO  ) , exchange-traded funds, and countless other types of assets are at your fingertips.

If you choose either of the "transfer" options, ask your new plan administrator or IRA provider for information on how to get the money from the old account. You want to avoid having a check sent to you directly. If this happens, you'll have just 60 days to get it to a new account. Plus, 20% of the money will have been withheld by your old plan (per IRS rules). You'll have to come up with that 20% when you deposit the money in your new account, and you won't get it back until you claim it as a tax credit when you file your taxes.

Not sure what option is best for you? Don't know what to do with the money in your 401(k) or IRA? Then schedule a free "get acquainted" meeting with a Garrett Planning Network fee-only financial advisor. Visit the Locate an Advisor page and click on your state. For a limited time, advisors with a Motley Fool logo next to their names are offering a 10% discount to Fool readers.

Robert Brokamp is a Certified Financial Planner and the lead advisor for The Motley Fool's Rule Your Retirement service. Both he and the Fool own shares of Berkshire Hathaway, which is a Motley Fool Inside Value choice. Berkshire Hathaway and Ford Motor are Motley Fool Stock Advisor recommendations. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is the best deal you'll find.


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F $15.61 Down -0.07 -0.45%
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