I was sitting at my office the other day, and I received a phone call from my little sister in Arizona. She was calling me as a sounding board, as many siblings are for each other. She was considering changing employers and wanted my input.
After her decision was made, I asked her what she was planning on doing with the 401(k) she had with her current employer. She sounded surprised by the question. What should I do? That is a very good question that needs to be explored. Not only if you are changing employers but also if you have been laid off or your employer closed its doors: What do you do with your 401(k)?
Your 401(k) is "portable." Unlike some other employer-sponsored retirement plans, you can take your 401(k) with you when you change employers.
Within certain limits, the accumulated funds in your 401(k) plan can be rolled over into your new employer's retirement plan without penalty. If your new employer's retirement plan doesn't allow such transfers, you can roll the funds to an individual retirement account (IRA). Considering the average worker changes jobs five to eight times during his or her career, this can be an important advantage.
In most cases, a 401(k) plan being rolled into an individual retirement plan can be done by a financial professional with little or no cost to you.
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What happens if you take the money in my 401(k) plan now and not wait until you are retired? If you decide to take your money out early there will be a mandatory 20 percent withheld for federal income tax and 10 percent early withdrawal penalty. If your 401(k) plan is the largest asset you have, other than your home, you potentially could lose a significant amount of its value if you choose to take the cash.
Can you leave it with your current employer? "Yes," is the short answer to that question. My real question is why. Why would you want to have a 401(k) plan at a previous employer? Who is watching it for you? How do you review it? What if you want to change investments or beneficiaries? Whom do you contact? What happens if you should pass away? Your beneficiary has to file at your previous employer and your present employer. Considering the frequency the average person changes jobs this could turn out to be a real headache for the beneficiary.
The smart choice is to take it with you.
What are your contribution limits in your new employer's 401(k) plan versus an IRA account? A 401(k) offers higher contribution limits, and they are pre-tax contributions. This means that you can put away more money, and because it comes out of your paycheck before the tax does, you will be better off than an after-tax contribution.
Let me explain. If you are in the 27 percent tax bracket, it effectively costs you $73 of spendable income to save $100 for retirement. If you saved the same amount for an IRA account, you would spend $100 of spendable income and deduct it off your gross income when preparing your taxes.
In a 401(k) plan you can save $14,000 a year. The contribution limit increases to $15,000 in 2006. In an IRA account, you are able to save $4,000 (2005-07) and $5,000 in 2008. Both the 401(k) and the IRA accounts have a "catch-up" clause that allows individuals that are 20 or older to increase their contributions over the regular limits: in a 401(k) it is $4,000 additional dollars (2005), and in an IRA it is $500 (2005).
Your new employer doesn't have a retirement plan? Then roll the previous 401(k) plan into an individual retirement account and continue to make monthly contributions to the IRA.
With all of the layoffs and business closings going on in the Northland, it is imperative that you are well informed before you take your 401(k) plan. It should not cost you to enlist the help of a financial professional to assist you with the proper paperwork to correctly move your present 401(k) account to a new one or an individual retirement account.
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If you should decide not to heed this advice, it may cost you 30 to 40 percent of your hard-earned savings. Please make a phone call to your trusted financial advisers, as my sister did, and get the correct information.
Jim Booth is the CEO and founder of Booth Financial Advisors,he can be reached at 279-6005 or jim@boothfinancialadvisors.com .
