Help a Reader: 401k Rollover

I recently received this question from a reader:

I have roughly 85k in a company 401(k) plan. I'm in the process of changing employers. What should I do with theses funds? I'm 38 yrs old and obviously will be building another retirement with my new employer. I hear that an annuity with monthly draw-downs will give me access to my monies without the tax burden if I just cash out. Or is an IRA the best option?

I've always rolled my 401k money into an IRA so I could then control/manage it myself with the investments I wanted to make.

How about you? What would you advise in this situation?

Comments

[LC]

First wait till you start your new job and take a look at your new 401k plan.

If you like your new company's 401k plan, roll it over into that. This is the best option since you only have 1 account to manage. This is especially easy if the 2 plans are through the same brokerage. The benefits person at your new job should be able to help you.

The 2nd best option would be to wait until 2010 and then convert it to a Roth IRA. The reason to wait is that in 2010 they allow you to spread the tax burden of doing so over 2011 and 2012. But, if you make more than $110k ($160k if married filing jointly) than this is not an option. The reason this is a good option is because you should be contibuting to a Roth anyway since you never have to pay taxes on that money or its gains in retirement.

If you don't particularly like your new company's plan, you should still contribute to it going forward, but look at other options for your old money. If your old plan is pretty good, there's no harm in leaving it there. It will just continue to grow until you retire. The only thing to be sure of is to still keep track of this money and make sure you keep them updated of any changes to your contact info. This is what I did. I don't know of any way to take money out without a penalty. The other option is to roll it over into a traditional IRA.

[Kevin]

I prefer using an IRA as well for the reason FMF mentioned - control over investments. Although, if your new 401(k) has funds you like it might be worth looking into.

The annuity you are referring to is based on a series of substantially equal periodic payments over the life expectancy of the participant. This only avoids the 10% penalty on early withdrawal, so you'll still pay regular income tax. You have to keep taking it out until you reach 59 1/2. I didn't look at the tables, but I'm sure your life expectancy is probably 30-35 years so you'd get about $2,400 to 2,800 a year under that method. Why would you want to withdraw retirement funds anyway?

[J]

Like Kevin I don't understand why you would want to draw money now, but still an interesting question to whether moving into an IRA or the new 401k is better. I think the IRA move is good because you get control, but also you can convert to the Roth in 2010. You might take a big tax hit on the conversion, but for people who can't contribute to a Roth due to income restrictions this seems like one of the only ways to get a good chunk of money into a Roth account (via a 401k rollover to normal IRA now and conversion to Roth later).

Related to this question is the issue of timing on rollovers. Given the craziness in the market moving money between accounts at this time seems very risky. It takes a couple days for the rollover so it seems there would be a chance your money might be out of the market in limbo during a big upswing. I have heard others say wait until Christmas time when markets are less volatile because of the general slow down in economic news. Most plans allow you to keep your money in your old 401k indefinitely as long as you have more than $1,000 or $10,000 I think.

[Jim]

I would either wait to roll it into your new employers 401k or just roll it into an IRA.

I question why you'd want to go with an annuity. Is that a variable annuity some salesperson is pitching to you or is it a qualified annuity option your 401k offers? In either case I don't see any real benefit to going with an annuity over an IRA. DO you think an annuity would avoid taxes on the 401k? I'm pretty sure it won't.

Jim

As an aside, don't count on the 2010 roth conversion loophole being there. Not given the current situation. Heck, we already had one congressman suggest that the tax-free nature of roth iras should be eliminated for people above a certain income level. (I know, the guy is clearly an idiot. He views the tax break as a "subsidy" by the government.). While I am hopeful the guy stands alone and none of his other colleagues would dare play with the tax status of retirement accounts to the detriment of the consumer, I fully expect them to eliminate the 2010 rule.

As an aside, don't count on the 2010 roth conversion loophole being there. Not given the current situation. Heck, we already had one congressman suggest that the tax-free nature of roth iras should be eliminated for people above a certain income level. (I know, the guy is clearly an idiot. He views the tax break as a "subsidy" by the government.). While I am hopeful the guy stands alone and none of his other colleagues would dare play with the tax status of retirement accounts to the detriment of the consumer, I fully expect them to eliminate the 2010 rule.

[Apex]

Actually the 2010 rule is a short term tax boon for the government. It will bring in all kinds of extra revenue because when you convert to the Roth you have to pay income tax on the full conversion. Granted this means revenue is lost in the future but most of these guys only care about what the near term looks like because thats what determines their election status.

[ProsperityJunky]

I would recommend rolling over to an IRA for the same reason: more control/flexibility with investments. The only downside of not going into your new 401k is that you can't borrow against the money in the IRA like you could with the 401k. If your new employer offers a really great 401k with lots of investment options the either one is good choice.

[rwh]

If you roll over the money into an IRA or move it to another company plan make sure you do an institution to instituion transfer. Don't take formal possession of the money from your former employer before moving it; you will be subject to a 20% penalty.

Also, a question: If this person did want to take the money in a way that avoid the 10% penalty and just pay the income taxes on the distribution each year, why not take the annual distribution and put it in a Roth IRA each year? It seems like the same thing as converting to a Roth in 2010, but instead of having to do it 2 years, with the corresponding major tax bite, the conversion could be done over 20 years instead. The original, undistributed 401k money would still grow tax deferred , and the new Roth money would grow tax free.

Just a thought.

[Kevin]

rwh - you're not subject to a 20% penalty for doing a transfer yourself.

You are referring to the fact that most companies will automatically withhold 20% in federal taxes, but you are still required to roll over 100% of the funds distributed. You'll likely get the 20% refunded with your tax return, but have to come up with the money in the meantime.

[rwh]

Kevin:

It was my understanding this was a penalty and not a tax. I think I remember you saying you're an accountant so I'll defer to your knowledge on the subject.

[Tarah]

You can do both the annuity and the IRA, if you want to. You just have to have the salesperson set up the annuity as an IRA. What's nice about that setup is that you will never have to pay taxes on the gains, just the principal when you take it out.

BTW: Be careful what kind of annuity you get. Some are set up so you can never access your money without a penalty, but the good ones only have a 5-10 year penalty period at the very beginning. Also, some annuities don't have any investment fees, although those are usually either equity indexed or fixed.

[Justin]

You won't be subject to any tax or penalty if you do a direct institution to institution rollover.