What to Do With a 401k When You Change Jobs

When you change jobs, you have three good 401(k) moves and one bad one.  Don't let your 401(k) plan get lost in the shuffle--it's just as portable as your Palm Pilot, and picking the right rollover strategy can boost the return on your nest egg.  Every company has its own set of rules, so check with your benefits office to make sure you can actually implement the strategy of your choice:

Good and simple:  Don't touch your 401(k)
If you have more than $5,000 stashed away in your former employer's 401(k) plan, you can usually leave it there until you retire.  That makes sense if you are happy with the investment options.  In most cases, you can transfer the money later if you change your mind.  One possible drawback: You won't be able to borrow against the account.

Good, but takes effort:  Roll your money into your new plan
Even if you are not eligible to participate immediately in the 401(k) plan at your new job, many companies will let you invest your former plan's money right away.  If your new employer's plan has enticing investment options, this move's a winner.  By consolidating your 401(k) accounts, you simplify your portfolio management.

In most cases, you just sign a couple of forms to arrange the transfer, although your old company may take a few weeks to close your account.  "With larger plans that have daily valuation, the rollover is usually pretty quick," says Bill Knox, an attorney with investment firm Bugen Stuart Korn & Cordaro in Chatham, N.J.  Plans that do not value accounts daily may take longer--several months or more.  During this transfer period, unfortunately, your money will not be invested in the market.  But the wait may well be worth it, despite the annoyance.

If you go this route, make sure that your old company writes a check for your balance directly to the trustee of your new employer's plan--a so-called direct rollover--and not to you.  Otherwise, your old employer will be required to withhold 20% of the amount for taxes.

Good, but some drawbacks:  Roll your old 401(k) account into an IRA
Perhaps your new employer doesn't offer a 401(k).  Or the plan doesn't accept rollovers.  Or the investment options it offers don't give you the level of control you want.  If that's the case, your best move may be to open a rollover, or "conduit," IRA.  With this self-directed plan, you can invest in a much broader array of investments--including funds, stocks and bonds--than are available in most 401(k)s.  And as long as you keep this IRA separate from your other investments, you may be able to roll it into another 401(k) plan later. You can also consolidate money from any other 401(k) accounts you may have held into one giant rollover IRA.  You can transfer 401(k) monies only to a traditional IRA, not a Roth.  (You may be able to convert that IRA to a Roth--but you'll have to pay the taxes.) And be sure to open your account before you ask for your money, so your employer can make a direct rollover.

This option may be particularly attractive for older investors since, as Knox points out, IRAs give you more flexibility in estate planning.  That's because most 401(k) plans only permit you to name your spouse and, sometimes, your children as beneficiaries, but not grandchildren or other relatives.  With IRAs, you can name any beneficiary you choose.  Also, with IRAs, you can begin taking distributions before age 59 1/2 with no penalty, as long as you annuitize the withdrawals.

Among the drawbacks: You cannot borrow against an IRA, and you will have to track more than one plan.  And complete flexibility can be troubling if you're not inclined to research your choices.  Also, you must begin taking distributions at age 70 1/2.  With 401(k)s, you can delay withdrawals and keep contributing, as long as you are still working.

BAD:  Cashing out the IRA
More than 60% of job changers make the worst choice: withdrawing the money. Many are forced to do so because their accounts are worth less than $5,000 and they haven't decided where they want their money to be transferred.  What a waste! For starters, there's that mandatory 20% federal withholding tax (not to mention state and local taxes), plus the 10% penalty if you are under 59 1/2. And you give up the tax-deferred returns you could be earning on that money over the next 10 or 20 years.  Consider this option only if you face a serious emergency.


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