Protect retirement funds when changing jobs

One important task that is often overlooked when people transition from one job to another, however, is protecting the retirement savings amassed in a company 401(k).

Retirement plan assets may be one of the most important things you take with you as you leave an employer, and there are important decisions to make regarding how the transition is handled. It is essential to evaluate all of the options. Quick, impulsive decisions can be costly.

Take the time to map out a plan to protect retirement savings. Careful management and wise investments will help ensure funds will be available when they’re needed.

Examining available options

The responsibility of safeguarding your money falls on your shoulders, and you will generally have four different options for your plan balance:

• Leave the funds where they are. Keeping retirement savings in the former employer’s 401(k) is a convenient option that may be a good idea if you are happy with the investment alternatives and fund performance, or if you need additional time to explore other options. Although you won’t be able to make any additional contributions, you can still benefit from tax-deferred compounding of any investment earnings. This option may not be available if your vested account balance is less than $5,000. Be sure you understand all of the company’s 401(k) policies as well as federal rules on distribution requirements.

• Transfer savings to the new employer’s plan. Moving savings accumulated through previous 401(k) plans to your new employer’s 401(k) plan allows you to make contributions to the new account and keep all of your funds in one place, minimizing time spent monitoring and tracking your funds. However, before transferring money you should compare the benefits of the two plans. Some of the factors to consider include fund performance, costs and fees, scope of fund choices, rate of return and ease of manageability. Be sure that the new plan is an upgrade.

• Roll over into an IRA. It may be a wise decision to move money into a qualified retirement account, such as an individual retirement account. Putting your savings into an IRA allows your investments to continue compounding tax-deferred, while offering maximum control over asset allocation. An IRA usually gives more flexibility and decision-making power than a 401(k) plan, which may offer limited choices. An IRA will likely have more investment options to choose from based on individual needs and expectations. Rolling retirement savings from a 401(k) into an IRA also allows you to avoid current taxes and penalties that may apply to an early withdrawal.

There are a few potential drawbacks to be aware of when considering whether an IRA is the best choice for your situation. Generally, account holders cannot borrow against their IRAs, but you may be able to borrow against the value of your 401(k) account. Additionally, a 401(k) account offers the highest level of protection from creditors; assets in an IRA may be taken to satisfy debts in certain scenarios.

One caveat when rolling your funds over to a new 401(k) plan or an IRA: be sure to have your old employer transfer the funds directly to your new employer or to an IRA you have already established (direct rollover). If you follow federal rollover rules, the transition will be seamless and no federal income tax will be withheld.

• Cash out retirement savings. Although it may seem tempting to take the money and run, a cash distribution can lead to hefty taxes and penalties and put hard-earned savings in jeopardy. When retirement assets are paid directly to you, your employer is required to withhold a minimum of 20 percent for federal taxes. In addition, if you don’t meet minimum age requirements when the distribution occurs, you may be subject to an additional 10 percent early distribution penalty. Cashing out your retirement savings is almost never advisable unless you are faced with no other choice.

No matter which option you choose, it would be wise to discuss your particular situation with a qualified financial planner. The laws governing retirement assets and taxation are complex. A tax or financial professional can help you determine the most effective strategy for preserving your retirement savings to help ensure that your financial cushion will continue to grow into your retirement years.

Paula Dougherty, CFP, ChFC, CLU is a Certified Financial Planner with Ameriprise Financial

in Springfield. She may be reached at paula.j.dougherty@ampf.com.