Last week I talked about how I always rolled over my 401k into an IRA when I went from one job to another. This week, I want to highlight an article from Money magazine that says, "When you leave a job, doing the wrong thing with your old 401(k) can cost you a big chunk of your savings. To retire rich, master the art of the rollover." Here are the issues regarding what to do with your 401k and why they are so important to your financial well-being:
Should you leave your money with your old company? Is that an option? Do you roll over into an IRA? How do you do that?
Don't kid yourself: The stakes are high. Make the right decision, and your portfolio grows faster and lasts longer. A misstep could mean years of careful saving lost to taxes and penalties, not to mention bad investments.
"Most people have no idea what the rollover rules are," says accountant Ed Slott, author of Parlay Your IRA into a Family Fortune. "And it can be difficult, if not impossible, to undo a mistake."
Still, you can handle this. You just need to ask the right questions about whether to move your money and if so, where and how to invest it. The calculus is different depending on whether you're changing jobs or getting ready to retire, but the mechanics are the same either way.
Money then notes that there are four options for your money -- three of which are good. The choices:
OPTION 1: Stay with my old 401(k)
OPTION 2: Roll over into an IRA
OPTION 3: Roll over to my new 401(k) plan
OPTION 4: Cashing out
If you haven't guessed, the last one is the one to avoid. The worst thing you can do is cash out your 401k.
The article then gives some investment options for the money depending on the stage of life you're in. The piece finishes with this good advice on the proper way to rollover a 401k:
First you have to decide that a rollover is the right thing to do with your 401(k). Then you call the broker or fund company you want to invest with if you're moving to an IRA, or your new 401(k) administrator if that's the direction you're going. Most companies will walk you through the process, fill out the forms for you and even call your former employer to get your money moved. If yours won't, contact your old company to arrange a "direct rollover." Your ex-employer will then make a check out to your IRA trustee or your new 401(k) administrator, not to you.
Oops. What if there's a mistake? If your old company writes the check to you instead of to the new trustee, you have 60 days to invest that money in an IRA or in your new company's plan. You will also have to come up with cash to make up for the 20% automatically withheld for taxes. WARNING! If you miss the 60-day deadline, you'll have to pay income tax on the entire amount of your account that year, plus a 10% penalty. That two-month window also applies if the bank or brokerage makes an error--it happens occasionally--and accidentally lists your account as taxable rather than tax deferred. So make sure that you review any statements you get to ensure there are no slipups.
I've done this a few times, each with Vanguard, and they've been very, very helpful in the process. In addition, I like Vanguard because their fees are low and they have a wide range of index funds.
For more thoughts on retirement, see these posts:
- Figuring Out Your 401k
- Why You Need a Roth IRA
- Three Ways to Make Sure Your Retirement Savings Outlasts You
And here are some on making the most of your investments:
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