401k Rollover Options

Last December, when I left my previous employer to start my own business, I had an important decision to make on what to do with my existing 401k.  Luckily, being a financial planner, I knew exactly what I was going to do, but many others that are not in the profession or really don’t have a good grip on their financial situation might not be as fortunate.  When changing jobs, the decision that you make to do with your 401k could be a costly one if the wrong decision is made.  It’s important to know the different options that you have on what to do with your 401k whenever you leave your current job.

Cash Out 401k

The only reason that I have this option here is because you would be surprised the amount of people I talk to that elect this option.  The most common reasoning I here, especially for 401k plans that have matching, is that it’s “The company’s money” not “theirs“.  Wow!  Isn’t that great reasoning?

By taking “The company’s money”, now that person is stuck with a 10% early withdrawal penalty plus ordinary income tax.   Typically, when you cash directly from your 401k they will hold 20% standard plus the 10% early withdrawal penalty.   Obviously, this was not the direction I was going to go.

Leave the 401k There

My previous 401k at A.G. Edwards & Sons was one of the best around.  I don’t think I’ve seen another that had such a wide array of solid investment choices.  I guess one could have made the argument to leave it there, but considering my circumstance, that probably wasn’t the best idea.  Considering I was leaving to work for a competitor, LPL Financial, it definitely made more sense to take it with me.

I have heard of instances where people have left their 401k’s with their previous employers and have had difficulty trying to get access to the funds after a significant period.  The likelihood of this increases if your previous employer comes under financial duress or merges/gets bought out by another company.

Transfer The 401k to a New Employer

Most people have the option to transfer there old 401k into their new 401k with the new employer.  In the past, this used to be more difficult, but with recent government regulation changes, it’s much more easy.  While this could be a good decision, a lot depends on the new options that are in the new 401k.

In my case, since I was essentially starting my own business, this was not an option for me.  What did I do?  Read on to find out…..

Rollover Your401k Into Your Own IRA

Rollover into IRA

I would argue that this would be the most advantageous thing to do.  By rolling over your 401k  into an IRA, you will further diversify from your new plan, meaning that you can utilize different investments options that complement what you would have in your new plan going forward.  In addition to that, you also have full control on the investment decisions inside the plan whereas in a 401(k), you are limited.  You have full reign to make all the decisions that you want and you may even seek the counsel of a financial advisor to help direct you in what investment direction that you would go.

Other Good Reads:

• Here what Patrick from Cash Money Life did when he was faced with a similar situation.
• Doing so in a treacherous market could be tricky.  Check out Consumer Commentary’s take.
• Similar steps at Smart Money Life: 401k Rollovers
• At BluePrint For Financial Prosperity, a reader was wondering if now was the right time to do rollover their 401k.   Somebody very wise left a great comment…

Securities offered through LPL Financial, Member FINRA/SIPC

Over the weekend while attending my town’s Friday night football game, I struck up a conversation with an acquaintance of mine, and we started talking about the market. The fellow I was talking about was a believer in the market, and knew that the current crisis that we are in would eventually pass, and the market would continue to strive as it usually does. What he found most peculiar was with some of the sediments of his fellow co-workers, who were participating in the 401k. His co-worker’s belief was that with the market being as bad as they were, they were going to no longer defer to their 401k, and refrain from taking advantage of the pre-tax contributions into their retirement plan.  They were giving up free money! He was stunned by his co-worker’s remarks, and as equally as I, and compared that to a conversation that I had, with some other workers from another local employer.  It prompted me to write this blog in regards in to things you should not do when it comes to your 401k.

1. Do not stop contributing to your 401k no matter what.

Just because the markets are down does not mean you should not contribute. In fact if there was a time ever to contribute, this would be the time. The simplest reasons is that right now despite the market’s turmoils, currently the market is at a discount, and what that means is that there are a lot of great companies that exist out there, that are currently “on sale”. This is a time to buy stocks, at a cheap price in hopes to benefit from the appreciation in later years. This strategy can also be called dollar cost averaging, which means as long as you are contributing on a consistent or periodic basis, you’ll take advantage of buying shares at a lower price in down markets, and compare that to buying shares at a higher price in up markets, which should then all balance out for a dollar cost average.

If the market has you completely terrified, then consider changing all future contributions to short or intermediate bonds.  At least that way you’re money is making a little interest while the market tries to figure itself out.

2. Do not put all of your 401k into the money market.

While I understand the disbelief in the markets right now to where you want to shift all of your money into the money market, by doing this would be a great mistake. If you believe that making money in the market is to buy low and sell high, then by shifting your money into the money market from your other investments, it would be the exact opposite; buying high and selling low. If you’ve seen your 401k depreciate in the last several months, the only way to get that back is by staying exactly where you’re at.

Now, I understand for those nearing retirement, that this can be a compromising situation, but if you visit the rule of 72, meaning that you take 72 divided by the interest rate on your investments, and that will tell you how long it will take to double your money. That also, too, will give you an indicator how long it will take you to recoup the losses that you have incurred. By shifting to the money market, chances are, you are making somewhere in the 2% interest rate, which means it would take you almost 20 to 30 years just to double your money, and to recoup your other money that you’ve lost, would be a great time.

3. Do not borrow against your 401k.

This can be said in an up market or down market, but I had to throw it in there. Borrowing against your 401k is never advisable, especially in a down market. Look to start an emergency fund of some kind so that you can have that to fall back on in case of an emergency. If you don’t have an emergency fund, start one now. There’s no sense in contributing to your 401k if you have to pull it out just pay the bills.

Securities offered through LPL Financial, Member FINRA/SIPC.

As you’ve read in other posts, I’ve talked about the importance of a 401(k) as well as a Roth IRA. Many clients have asked which one do I do over the other. A basic rule of thumb is if you do have a 401(k) that does have a match, take that first. The reason being is that that is free money and there’s no reason to pass up free money. Most 401(k)’s only match up to a certain percentage, so at least contribute as much as they match.

After the free money, Go for the tax-free money

If you have satisfied that and you still have more money to save, then let’s shift gears and let’s take a look at the Roth IRA. With the Roth IRA, you are allowed to put in up to $5,000 a year, $6,000 if you’re over the age of 50. Our goal then is to max out the Roth IRA after taking full advantage of the free match in the 401k retirement plan. Once the Roth is completely maxed out, then we come back to the 401(k) before we max that out, which is $15,500 per year up to $20,500 after over the age of 50.

Another case for Diversification

To further support this strategy is the simple principle of diversification.  Most 401k’s have limited investment options.  By opening a Roth IRA, you can then do investment options that are unrelated to your 401k, thus diversifying your portfolio even greater.  This is strategy that did in my Roth when I used to have a 401k with my previous employer.

Ahead Of The Game

If you’ve managed to max out both your 401(k) and your Roth IRA, well, you’re definitely ahead of the game, and after that we can discuss further options that you could possibly consider.

What Other Bloggers Are Saying:

Cash Money Life

The Dough Roller

Moolanomy

Securities offered through LPL Financial, Member FINRA/SIPC

Most 401k’s can be complex and confusing. Follow these 5 easy steps to get going towards saving for your future.

1. Start Now

If you haven’t started investing in your 401(k), do it now. The sooner you start, the longer you have to have your money grow and work for you. It comes directly out of your paycheck, so you probably won’t even notice it, so go ahead and start.

2. Take Your Free Money

Many plans will match dollar for dollar up to certain percentage, but if you don’t participate, you get nothing. Don’t let the free money pass you by.

3. Save On Taxes

Money you put in comes out pretax so pay less of a tax bill. When you retire and you start drawing it out for income, you can potentially pay less income tax.

4. Know Thy Investments

All 401(k)s are created differently. If you want to be aggressive, don’t pick an investment that’s called “Total Return”. It may actually be an investment that is all bonds, which would be way too conservative for your goals. Have a certified financial planner review your options to make sure you have solid investments that match your risk tolerance. I’ve seen folks that are in conservative investments when they should be aggressive and I’ve also seen folks nearing retirement that are invested way too aggressively. Don’t let that happen to you. Understand what you have

5. Never, Never, Ever Borrow From Your 401k

What other bloggers are saying:

• Moolanomy: Should I borrow from my 401k
• Get Rich Slowly: How to Cope with a lousy 401k
• Everything Finance: How to Choose Funds in your 401k

Being a financial planner for several years you think you’ve heard them all. Several years ago I was able to talk to individual who worked for a Fortune 500 manufacturing company. He was in his early 50’s and had been with the company for well over two decades. The company offered a decent pension plan and had just implemented a matching 401k about 8 years prior.

401k, What’s That?

The gentleman was offered an early buyout due to his company being merged with another and he was exploring his options. He made decent money and informed me of the cash buyout that he was being offered for the pension. Knowing the company had a decent 401k, I inquired to the balance he had accumulated. Here comes the bomb……nothing. Not one single dollar. Maintaining a straight face, I asked the simple one word question, “Why?” His response was, “I don’t invest into that stock market”. Knowing that his company matched dollar for dollar for the first 3% and then fifty cents on the dollar for the next 5%, I was in shock. I didn’t know what to say, so I didn’t say anything and just moved along with rest of the meeting.

Still In Shock

I’ve never forgot that conversation and made me wonder how many more people out there have matching 401k’s that don’t take advantage of them. Did he not know that his 401k had a money market option? He could defer 8% of his salary and not have to worry about the “stock market” and get free money from his company. Since my encounter with him, I make the diligent effort to ask anybody I come across that has a 401k if they are taking their free money. Even if they are not putting their money in the market, they can least take the match. That’s more return that they’ll get in their savings account any day of the week.

Understanding the Match

Using the example above, let’s say you work for the same company and make a salary of $50,000. In that case if you were to put 3% of your salary ($1500 for the year) then your employer would match another $1500. So you just doubled your money and now have $3000 saved towards your retirement. If you then save an additional 5%, that would be $2500 plus the company would match half of that for $1250. So if you were utilizing the full 8% of your salary, your own money that you would contribute would be $4000 and your employer would tack on $2750 for a total of $6750. Not including any market fluctuation, that is a 68.75% return on your money! And how much do you make if you don’t participate in the 401k. O. Zilch. Nada.

So go out and participate and take your free money and run off to a comfortable retirement!

Securities offered through LPL Financial. Member FINRA/SIPC.