What to do with your 401K

March 20, 2009 4:27:35 PM PDT
How to manage your 401K in tough economic times.

Six tips for 401(k) investing in today's volatile market:

  1. Keep doing the right thing. Continue to make investments to your retirement accounts. Our economy isn't the greatest right now, but the fact remains that practically all of us will retire from the work force at some point in our lives. Even those of us who love work and can't imagine doing anything else will come to a point where we can't work any longer.

  2. Don't succumb to the market roller coaster. It is common for people to have an emotional reaction to the market's ups and downs.

  3. Think about risk. Investing is always about finding that delicate balance between our desire for high rates of return with the dread and pain that comes from losing our hard-earned money. Determining the level of risk you're comfortable with is incredibly difficult and sometimes is revealed only when rough times, like now, arrive.

  4. Rebalance your investments.

  5. Take a close look at your account. While you're rebalancing your account, take a close look at what's in it. When you allocate your contributions, which investments are they going toward? Do you still feel good about those choices? Your plan might have added new choices since you enrolled. Now is a good time to take a look at those new choices and see if any of them make sense for you.

  6. Treat your account like a lockbox. This year has been tough for many working families. In times like this, it's tempting to tap into your retirement savings accounts but the penalties and taxes will cost you in the short and long term.
What to do when you lose your job

Roll over your 401(k) account. When it comes to preserving your retirement savings, you've got three choices.

  • First, you can make a direct transfer to what is known as a Rollover IRA (the human resources department at your employer will have the forms and any broker-dealer can help you with the transfer). I like this option because your entire account balance will transfer tax-free.

  • Or, if you instead opt to get a check from your former employer, you have 60 days to roll it over to an IRA. In general this is not a good idea because your employer will be forced to withhold 20 percent for prepayment of federal income taxes. Also, if you miss the 60 days and you are under 59 1/2, you will be tagged with a 10 percent penalty (state income taxes and penalties may also apply).

  • A third choice is to leave your money with your former employer. Although this may not be ideal because you will be tied to the investment choices in your former employer's plan, it does spare you having to pay taxes or penalties. And finally, if you just "cash out," you'll owe taxes on the entire amount, plus potential penalties. And you'll be raiding your retirement account. So for the sake of your retirement, go with one of the other choices.

    Create a budget, and cut your spending. One of your first tasks should be to figure out what you're going to live on while you look for a new job. You might have a few months of severance pay. Your spouse might have an income. You might be eligible for unemployment benefits (as described above). And you may have an emergency fund, other savings or a home equity line of credit. You might also be able to work part time while you look for a full-time job.

    Now take a good hard look at your spending. Some expenses you can't cut, or at least not easily, like your rent or mortgage, utilities, insurance, etc. But you'll probably find plenty of opportunities to reduce your outflows while you're searching for a new job.

    See if you qualify for other forms of assistance. There are several tax benefits that might be available to you, from the new "recovery rebate credit" (for people who didn't receive a stimulus payment in 2008 but are now eligible because of changed economic circumstances) to the 0 percent capital gains and qualified dividends rate (if your income is low enough). Check with a tax professional or the IRS to find out more.

    Look for a job! It may seem obvious to say, "Look for work." But losing your livelihood can be depressing, and given the current economic outlook, it's easy enough to put off the search until the situation improves. My advice is to start your job search right away. If your industry is severely depressed, work on applying your skills and experience to another one. Take a part-time job. Go freelance for a while if that's an option. The more initiative you take, the greater your chances of finding a new job.

    Rollover IRA logistics

  • What is a Rollover IRA?
    A Rollover IRA preserves the tax-deferred status of your retirement assets from a qualified employer-sponsored plan such as a 401(k) plan, and allows you to avoid current taxes and early withdrawal penalties on payouts received from your employer's retirement plan when you change jobs or retire.

  • What if my employer sent my rollover distribution check made payable to me, rather than to Schwab?
    If your employer sends you your rollover distribution check made payable to you, you can deposit it directly into your Rollover IRA. Be sure to add your Schwab Rollover IRA account number on the check and deposit it within 60 days to avoid taxes and penalties. Your plan administrator may have withheld 20% for federal income tax. You can recover the deducted amount by making sure that you roll over the amount you received from your prior employer plus the 20% that was deducted.

  • What types of retirement plans are accepted into a Rollover IRA?
    Anyone receiving qualifying distributions from employer-sponsored retirement plans (401(k), 403(b), profit-sharing, money-purchase, QRP/Keogh, etc.) is eligible. Other types of plans, such as ESOP and Defined Benefit Plans, may or may not be eligible for roll over to an IRA. You may be allowed to roll over after-tax dollars and governmental 457(b) qualifying distributions. You should contact your Plan Administrator(s) to inquire whether or not your particular plan is eligible for rollover.

  • Once I roll over my retirement assets into a Rollover IRA, can I move my assets to my new employer at a later date?
    Yes. You can move your assets between employer-sponsored plans and IRAs. However, if you plan to move your retirement assets into another employer-sponsored plan, you may want to maintain separate IRA accounts for assets coming from differing types of plans, e.g., 401(k) and 403(b) since your new employer may or may not allow you to roll over commingled retirement assets.

  • Can I make contributions to my Rollover IRA once it is established?
    Yes, while you can make contributions to your Rollover IRA, please be aware that if you do make additional contributions, you may forfeit your opportunity to roll over your retirement savings into a new employer-sponsored retirement plan. Different plans determine which assets, if any, it will accept. You should check with your new employer regarding their plan-specific rules.

  • How can I avoid the 20% mandatory withholding income tax on my retirement payout?
    Request that your prior employer transfer all of your retirement plan payout directly into your Rollover IRA account.

  • My prior employer already sent me a check for my retirement assets and deducted the 20% income tax. Can I get that money back if I place the funds in a Rollover IRA?
    You are eligible to retrieve the amount that was withheld if you deposit your retirement assets into a Rollover IRA within 60 days. This must be equal to the amount of your distribution plus the amount that was withheld by your prior employer. By funding your Rollover IRA with 100% of your payout, you will receive the refund in the form of a tax credit when you file your tax return.

    If you do not make up with difference of the amount withheld, it will be considered as a distribution and it will be taxed as ordinary income. In addition, the amount can also be subject to a 10% early withdrawal penalty.

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