What should you do with the money in your employer’s retirement plan when you leave the company?
The standard answer used to be: Shove it all into an individual retirement account.
But it isn’t that simple anymore, especially with the expanded options available as a result of new rules that went into effect within the past year.
Here are some options to consider:
– Take it with you. New Internal Revenue Service rules allow you to transfer money from your 401(k), profit-sharing or other employer-sponsored retirement-savings plan to a new employer’s plan, if the plan allows it, even if you aren’t eligible to participate in the new plan for months. When you make an employer-to-employer transfer, the investments are converted to cash, which you then reinvest in the investments available in your new plan. Moving to a new employer’s plan makes sense if it offers good investment choices.
– Leave it behind. Many plans allow you to leave all–or some–of your retirement money in the plan when you leave or retire. This might make more sense than transferring the money to an IRA, for several reasons.
For one thing, you may prefer the investment choices. Michael McCarthy, a consultant with Hewitt Associates in Lincolnshire, says the major reason he sees people stay in company plans is to have access to guaranteed investment contracts, which promise preservation of principal and a fixed rate of return.
“A lot of retirees like the stable-income options, but there’s no place to get the equal investments outside a company plan,” he says.
Company-sponsored plans also are generally creditor and judgment proof. The money may be professionally managed, at a lower cost than investments you choose for your IRA.
And if you’re still working in the year in which you turn 70 1/2, you won’t have to start taking distributions, which you would have to do if the money were in an IRA.
Finally, you may be able to borrow the money from a current employer’s plan, which isn’t something you can do with an IRA. You can later transfer the money to a future employer’s plan or move it to an IRA.
– Cash out some of it. If you’re going to need money to start a new business, pay some big medical bills or send your kid to college, consider cashing out a portion of the retirement plan and moving the rest to an IRA. Although that normally would subject you to income taxes, plus a 10 percent penalty if you are under 59 1/2 years old, there are ways to reduce the tax bite.
For instance, you aren’t subject to the 10 percent penalty if you are 55 in the year you leave your job.
If you’re over age 59 1/2, you can use forward-averaging rules, which enable you to pay taxes as though you received the money over five years (or 10 years if you were born before 1936). But you can’t put some of your retirement-plan money into an IRA in the same year you forward-average. Forward averaging is an all-or-nothing deal.
– Grab the stock. If your former employer’s retirement plan includes the company’s stock and you own a lot of it, you might want to transfer it to your regular taxable brokerage account rather than an IRA. You will owe taxes, but only on the value of the shares at the time you purchased them, the so-called cost basis. The cost basis also will be the value used to calculate any early-distribution penalty you owe if you are under 55.
Meanwhile, you continue to defer gains on all the earnings that accrued since the stock was initially purchased (the “net unrealized appreciation”) until you sell the stock. At that point, you are taxed on the appreciated value at the long-term capital gains rate, which was just cut as a result of the recent budget accord.
In contrast, if you transfer your former employer’s stock to an IRA, you won’t owe any taxes until after you sell the stock and withdraw the money. But those withdrawals will be taxed at your ordinary income-tax rate, even if a good portion of the money results from long-term gains.
– Transfer it to an IRA. Despite all the possibilities, the simple solution–moving the money to an IRA–still makes a lot of sense for many people. You may save yourself some headaches and if you don’t co-mingle the money with IRA contributions you made yourself, you can later transfer it to a future employer’s plan.
If you decide to move the money to an IRA, save yourself a lot of trouble by having the money transferred directly. If you instead receive a check that you have to “roll over” yourself, your employer will withhold 20 percent of the money, since the IRS will assume you are planning to cash it out. To ensure that 100 percent of your account balance goes into the IRA, you’ll have to come up with that 20 percent out of your own pocket and wait until tax time to get that amount refunded to you. Nothing is simple.
Or maybe move it to several IRAs. Let’s say you need a bit of money coming in while you’re looking for a job. Split your money among several IRAs, and begin to receive a stream of payments (“substantially equal periodic payments” is the lingo) from one of them. The amount you receive each year depends on your life expectancy, your age and the amount in that particular IRA. Regardless of your age, you won’t owe the 10 percent penalty that generally applies to IRA distributions before age 59 1/2.
Once you initiate a stream of payments, you must receive the payments until you turn 59 1/2, or for five years, whichever is longer. There are no limits to the number of IRAs you can set up.
