Money Matters: Former-employer 401(k) plans: Leave or move?

By James Terwilliger The Daily Record Newswire Do you have a 401(k) or similar plan residing at a former employer? This might be the result of retirement, changing jobs or leaving the workforce temporarily. The key question is: "What should I do with the funds? Keep them intact or move them out?" When employees leave a company, generally there are five options available: * Take the money and run * Leave the money where it is * Transfer to a new employer's plan * Roll over to a Traditional IRA * Roll over to a Roth IRA Take the money and run Unless you are facing a catastrophic financial emergency, don't even think of this option. This is clearly a last resort. First, these assets are a key piece of your retirement nest egg. You will need them a lot more then than now. Remember, keeping the money invested will allow for tax-deferred growth. A $30,000 balance today can grow to $140,000 in 20 years at, say, an 8 percent annualized growth rate. And, that's without making a single additional contribution. Second, if you take the money now, the entire distribution will be subject to federal and state income taxes at ordinary rates. Twenty percent is required to be withheld by your previous employer for federal taxes. Additionally, if you are under the age of 59.5, distributions generally are subject to a 10 percent early-withdrawal penalty, although there is no penalty for distributions made to an employee who attained the age of 55 before leaving the company. Leave the money where it is If your previous plan offers some unique investments, a full array of investment choices and/or low internal fund and plan management fees, you may want to leave the plan alone. For example, the Kodak Savings and Investment Plan features low management fees and includes a Fixed Income Fund that is currently returning about 3.8 percent annually. Many Kodak retirees and former employees have chosen to keep their SIP plans intact. Taxable distributions are then available as needed without penalty, subject to the age restrictions mentioned above and the plan distribution provisions. Transfer to a new employer's plan If your new plan offers investment choices and/or fees that are superior to your previous plan, it may make sense to transfer and consolidate your old 401(k) assets into the new plan. On the other hand, you will lose some flexibility since you will not have access to the funds, other than through a loan, while you are working for the new employer. Roll over to a Traditional IRA This can be an attractive option for many reasons. Generally, IRAs offer a much bigger universe of investment choices than 401(k) plans, although you will want to make sure that you are not constrained by a limited choice of high-internal-expense "proprietary" funds that IRA investment firm representatives may be encouraged to sell. Also, if you have accumulated a number of small, disconnected 401(k) plans and IRAs over the years, there is great advantage to consolidating into one IRA. Doing so makes it much easier to develop and manage a well-diversified portfolio, including annual rebalancing, that supports your overall financial plan. In the past, estate planning options were better with IRAs versus 401(k) plans. That all changed with the Pension Protection Act (PPA) of 2006. Now, a non-spouse beneficiary is able to roll over an inherited 401(k) into an inherited IRA and stretch the IRA out over his/her expected lifetime. Previously, non-spouse beneficiaries generally had one choice: Take a distribution and pay the taxes. Roll over to a Roth IRA This also can be an attractive option, particularly for younger workers. The PPA made this option available starting in 2008. Prior to then, moving money from a past-employer's plan to a Roth IRA required two sequential steps. As an additional sweetener, the PPA removed all income restrictions for making this one-step process starting in 2010. As with any conversion of pre-tax money into a Roth IRA, income taxes are payable on the conversion amount in the year of transfer. So, be mindful that such a rollover will have tax consequences. But once the money is in the Roth IRA, all income and appreciation are tax-free for life as long as certain conditions are met. This summary covers only a few of the issues needing consideration. Be sure to consult with a trusted financial planner before making any change. What is right for you depends on your personal circumstances. The consequences of making a wrong choice can be disastrous. ---------- James Terwilliger, CFP, is vice president, financial planning, Wealth Strategies Group, Canandaigua National Bank & Trust Co. He can be reached at (585) 419-0670, ext. 50630 or by email to jterwilliger@cnbank.com. Published: Thu, Apr 14, 2011