Don't be like me (Amanda).
About six years ago, I left a job at another publishing company. At the time, I didn't understand much about investing or retirement planning, and foolishly thought I'd just lose my 401(k) retirement plan.
A month after I left, I started getting notices from my brokerage urging me to take action. Instead, I froze – I didn't know what I needed to do... and the thought of messing up and incurring a huge tax bill kept me from doing anything.
I was fortunate that the brokerage had a plan that simply rolled the 401(k) into a "rollover" IRA (individual retirement account) for me. Since it hadn't heard from me, it made the change automatically. I didn't owe anything and I could let it sit there for as long as I wanted.
Not everyone has that kind of luck. Usually, if you don't respond and have a low balance, typically $5,000 or less, the broker sends you a check (while withholding 20% for taxes). You have 60 days to then deposit it into an IRA of your own. And if you still do nothing, it can trigger a hefty tax bill and you'd lose about 30% of your savings.
Now, rolling over a 401(k) isn't just for folks changing jobs. If you're nearing retirement, you may want to roll your 401(k) into an IRA. That's because you might hold nothing but company stock, and you need to diversify. Or maybe you've changed jobs a few times and have several old 401(k)s still sitting with past employers – it's a good idea to roll them over into a single account to better manage them.
We believe in helping you take charge of your own finances. That's why we outlined the basic steps you need to take when deciding what to do with your old 401(k) account...
Is a Rollover Right for You?
First, compare your old employer's 401(k) with your new company's 401(k) plan and with an IRA that you would open on your own. In particular, focus on management fees and available investment options.
Usually, the IRA wins out... It typically has lower fees and many more investing options than a 401(k). But it does depend on your broker. Make sure you understand how much you'll pay over time in each type of account.
Second, decide if you want to roll over your account to a traditional IRA, a Roth IRA, or your new employer's 401(k). The main difference between a traditional and a Roth IRA is taxes. For a traditional IRA, your money goes in pre-tax and you pay a tax on your withdrawals. For a Roth, the money goes in after tax, and your withdrawals are tax-free.
It's important to compare your current tax bracket with what you expect to pay in taxes when retired. That will help determine if you should pay taxes now (for a Roth) or in retirement (for a traditional IRA).
(A new 401(k) will be taxed the same as your old one, so again, be sure to compare the fees.)
Third, if you choose an IRA option, open a rollover IRA account with your broker. If you don't have a broker, we covered how to find one in our issue, here.
And if you choose to roll the old account into your new 401(k), double check your eligibility rules. Some companies will not give you 401(k) access until you meet a time requirement (such as six months or a year of employment).
Next, ask your current broker to do a direct rollover. This wording is important – you do not want them to simply cut a check to you. Make sure they transfer the cash directly from one account to the other to avoid any tax implications.
Finally, look at your available investment options and choose what you'd like to own. Remember, purchasing stock makes you a partial owner of the company, so you want to choose well. This is the part I missed because of my inaction. So I lost out on potential gains and lower fees.
One last point... what if none of these options are ideal for you?
There are some tax considerations that are above our pay grade to cover here. For instance, if you have a lot of company stock or suspect your retirement income tax level will be higher than the capital gains tax level, we suggest speaking with a tax professional before rolling over an account. You can also check out the rules governing rollovers at the IRS website, right here.
If you're thinking about a rollover or even just trying to decide which investments to make in your retirement account, we've got you covered. Next week, we'll show you the best strategies for choosing funds in your IRA or 401(k).
Here's to a fresh start,
Amanda Cuocci & Laura Bente
March 11, 2018