One of the questions they must be asking themselves, is what do we do with our 401k?
It may seem the easy way out of the financial predicament enforced upon you by the depressing economy. But you also face the danger, that if you exhaust it now, what will you do when the need crops up again? You could be compromising on your retirement security.
You could also be liable to your withdrawal being taxed. The norm is that if you withdraw your 401k account before you are 59½, you will have to pay income tax and a 10 percent early withdrawal penalty.
The withdrawal penalty is waived if you have lost your job and have crossed 55, but then you sacrifice long-term gains for short-term relief. Decades of tax-deferred growth could be surrendered at the altar of burning need.
The right thing for you to do would be to discuss with your 401k plan administrator and establish how, what you have saved for your retirement, can be kept intact.
Offhand I can suggest three options. However each has its pluses and minuses. You can leave your 401k plan with your former employer, shift your account into individual retirement account (IRA) or relocate your old 401k into a new company’s plan.
Playing injudiciously with 401k savings is rather imprudent and one must tread cautiously. I will spell the pros and cons out for you to help you resolve your indecisiveness and hesitancy.
Option 1: Let Your 401k Remain With Your Former Employer
It may be tempting for you to leave your savings in your old company’s plan. It will save you the hassle and the paperwork of transferring the accounts to other chosen areas. As far as convenience is concerned, nothing could be better. However, it will limit your investment choices. Moreover, things could happen to your account, over which you exercise no control. If your account has more than $ 1000 but less than $5000, your ex-boss can transfer your savings into a Safe Harbor IRA, that too with an investment company that your ex-employer prefers. In the second scenario, if your savings are less than $1000, your employer can close your account, withhold 20 percent for taxes and other incidental expenses and send you a check for the remaining amount.
There are also certain limitations on the number of transactions you can make, extra service fees could be levied and there could be constrained beneficiary alternatives for terminated employees, like you.
An additional benefit would be that leaving your money in your 401k plan, would keep it safe from creditor predators. Federal law prohibits creditors from attaching 401k accounts. This protection would be taken away in an IRA account, since most states do not provide that protection.
Option 2: Put It Into An Individual Retirement Account (IRA)
Shifting your 401k into an Individual Retirement Account, (IRA) increases your investment choices and you can also exercise greater and more autonomous control over your money. If you want to withdraw money for purchasing a home or educational expenses, than the penalty clause is waived. However, you will have to forego the option of taking a loan from your account and in case you owe money to someone, your creditors can , through regulatory bodies, attach your account.
However, another option that has opened, since January 1, 2008, is that you can shift your account directly into a Roth IRA. Earlier it had to be routed via a traditional IRA. After you have paid your conversion taxes, all withdrawals are exempted from tax. However, that is subject to condition that you hold your Roth account for a minimum of five years and you must be at least 59½ years of age
Option 3: Re-employed? Put it Into Your New Employer’s Plan
If fortune favors you and you land a new job, it will resolve most of your problems. Maybe you won’t have to think about tapping into your 401k, your current jobs earnings will, hopefully ensure that. Coming to the 401k, you may decide to roll over your account to your new employers plan. Even though you will limit your investment choices, you will enjoy the fruits of credit protection. And you can also borrow from your account, as long as you continue to work for your employer – but in these hard times, who wants to leave anyway?
Things To Remember.
There are a few crucial things to remember when you are moving retirement money. A simple mistake could see you paying a large share of your money in taxes. To circumvent slip-ups, simply ask your company for a trustee-to-trustee transfer, also known as a direct transfer or a direct rollover.
What are the advantageous of such a transaction? It eliminates all chances of delay. Usually, when you take a distribution from a 401k plan to roll over, you must park the funds in the intended IRA within 60 days. Failing to do so will attract taxes, and if you are not the right age, maybe even an early distribution.
Another drawback of issuing a check is that your former employer must withhold 20 percent of your balance amount. Getting it back is a long drawn out process, hence the trustee-to-trustee transfer is the easiest and hassle free way to adopt.
The important things to understand is, that even though losing your job creates financial and emotional stress, stay calm and try to manage as best as; possible without touching a single penny of your retirement savings. Make your emergency fund or severance package count and somehow manage the period between jobs. These are difficult times, but they’ll pass and you will be happy in later years, that you allowed your 401k money to grow undisturbed.
