A man must be big enough to admit his mistakes, smart enough to profit from them, and strong enough to correct them- John C. Maxwell
The day has finally come. For some of you, it has been thirty-plus years at one job, and you are ready to enjoy retirement. For someone else, it may be less than twenty years, and you are ready for a change. For another percentage, you may only have one to five years at your current employer, and a better opportunity has presented itself and you are changing jobs. No matter which category you fall in, the question still remains, “What do I do with my 401(k)?”
Do you keep it with your current company and its custodian? If you are permitted to, keeping it with your current company and plan allows you to continue your tax-deferred growth potential and broaden your protection of your assets from lawsuits; it may also keep your investment fees and expenses low. However, you can no longer contribute to the old plan. Sometimes your investment options are limited to less than fifteen investment choices in company-sponsored plans.
If you are changing jobs, do you roll it over to your new workplace plan if permitted? This option lets you consolidate your 401(k)s into one account, while continuing tax-deferred growth potential. However, as just stated, sometimes your investment options are limited, with less than fifteen investment options.
A third option may be to roll over your 401(k) to an IRA that allows you to consolidate your retirement accounts in one place, while continuing tax-deferred growth potential. With some IRAs, you have access to a wider range of investment options, but you could be limited in the accessibility of your funds depending upon your age.
The fourth option, which is the most common (and typically the most expensive) mistake I have seen over the last twenty-one years in retirement planning, is a retiree having his or her retirement account paid directly to him or her in the form of a check instead of rolling the funds over to a self-directed IRA.
Cashing out your 401(k), or in this case “cleaning out” your 401(k), is for many the worst mistake a retiree can make for the following reasons.
First, whenever you cash in your 401(k) instead of rolling it over, your former employer is required by law to withhold a mandatory 20 percent tax on your entire account balance. You will then have sixty days to deposit the cash, including the amount withheld, in a new tax-deferred retirement account before Uncle Sam keeps the 20 percent and you become responsible for any additional income tax due. If you are going to roll over an old 401(k), make sure that you always have the check made payable to the new custodian. As a general rule of thumb, when rolling over a 401(k), do not have the check made payable to yourself.
Second, if you are under the age of fifty-nine and a half and you do not roll over your 401(k), in addition to the 20 percent tax withholding, you will have an additional 10 percent early-withdrawal penalty added to your previous tax amount.
Finally, there is the opportunity cost you lose when you clean out your desk and your 401(k). Opportunity cost refers to a benefit that a person could have received, but gave up to take another course of action. Stated differently, an opportunity cost represents an alternative given up when a decision is made. This cost is, therefore, most relevant for two mutually exclusive events. In investing, it is the difference in return between a chosen investment and one that is necessarily passed up.
When you sacrifice 20 percent (maybe 30 percent if you are under the age of fifty-nine and a half) of your retirement savings because you cashed out your 401(k) instead of rolling it over to an IRA, imagine how much more interest you could have earned if you did not give up those dollars.
If you are weighing your options regarding your retirement plan from a former employer, contact our office to schedule your no-cost, no-obligation visit to review your retirement account options.