401(k) Rollover Answers

Many people don't want to think about money. They don't like to talk about it and they don't like to think about it. Money is considered a necessary evil. We need money to live, but we think we need every single penny to live, so we don't save any of it.

The only place many of us save is in our 401(k) with work. The money goes into the account before we ever see it and somehow that makes it OK. But our mixed up feelings about money can have pretty severe consequences. Is your money working as hard as it could for you? What if you leave that job? What do you do with the money? Is a 401(k) rollover right for you? Here are some answers.

For a government created program, 401(k) rules are surprisingly simple. First, there is a limit to the amount of money that you can put into your 401(k) each year. For 2009 and 2010 it's $16,500. It may go up for 2011, but if it does it will probably only be an increase of $500.

If you leave the job, your 401(k) account will stay active. You can choose to roll it over to a new 401(k) at your new job or put it into an IRA. (More on rollovers later.)

You can start taking money (called distributions) from your 401(k) when you turn 70 and a 1/2. Or after April 1st the year after you retire, whichever comes first. (OK that part is not so simple.)

You can withdraw the money at any point in your life, but you take a 10% penalty and you are liable for the taxes on the money right away. These rules are designed to keep you from touching the money until retirement. No matter your current tax bracket, when you turn 70 it's bound to be less.

The rules governing 401(k) rollovers are pretty straightforward. The money has to go somewhere. It can stay where it is (which is a bad idea, as you'll see in the next section); it can go to a new home at your new job, or you can put it in an IRA -- an Individual Retirement Account.

A direct rollover means it goes into a new 401(k) account. This certainly the cleanest of your options. The money goes from one trustee to another and pretty much the government stays out of the way. An indirect rollover means that you're putting the money into an IRA. The government holds (usually) 20% of the money as possible taxes for 60 days. The 60 period also serves as a time where you can change your mind about where the money is going. If, at the end of the 60 days, the money is in the IRA, the government releases the 20% and it rejoins the retirement account.

So let's say you change jobs. The odds are that you will change jobs at least three times in your adult life. It's smart to roll your individual 401(k) to the new job. Here's why: You have all of your retirement money working for you. The more money you have, the more money you make. Let's say you had a 401(k) account from a job you held three years ago. It has $5,000 in it. Let's say that at your current job your 401(k) has $3,000 in it. Each of those accounts is chugging along, making money in a slow and steady way. But, if they were combined, so that you had $8,000 working for you, the results would be better. In the same way that two people can build a single wall faster, the two accounts, when combined, will work faster. Even if the math doesn't interest you, think about it this way: the $5,000 from your old job is costing you money. That's right. It's costs you money to keep the accounts separate. 401(k) funds don't run as non-profits. They are charging you fees every year that you keep that other account open. You just don't realize because the account grows a little each year, so the fees just seem like they don't matter. But they do.

It might not be a bad idea to have a separate IRA, or individual Retirement Account, in your financial portfolio. Remember the limit for contributions is $16,500, so you can put a little into an IRA while you're contributing to your workplace 401(k).

A lot of people find themselves with an IRA due to a 401(k) rollover. I think that's fine, as long as the IRA doesn't just sit there gathering dust. As I said earlier, all of these funds (even the 401(k)) have fees associated with them. If you are putting a little bit every month to the IRA, the account will grow that much more and the impact of the fees is mitigated.

One nice thing about having more than one retirement account is that you minimize the risks of investing. As we've all seen, the stock market is volatile and having more than one account, with more than one broker, can help spread the risk around. Each brokerage firm is going to handle their fund differently. In addition, you can have one fund that is set to higher or lower risk than the others. So while one fund, let's say your 401(k) is set to medium risk, as far as the investment strategy goes, another fund, your IRA, can be all with high risk (but high potential) funds.

Lots of people, when times are tough, think about borrowing against their 401(k). Taking a 401(k) loan might seem like a smart move, but it's not. Best case scenario means that you just robbed yourself of a couple of years of financial peace in your golden years. That's best case scenario. Worst case: You lose your job and then you owe every single dime repaid within 60 days. Yes, read that again. The loan comes due if you lose or leave that job. That kind of limits your option, right? What if it's a lousy job and you find a better one? Can you afford to take the new job knowing that you'll owe $1,000 or $5,000 or $10,000 in 60 days? It's important to think this through before you act. Is there another, better way to raise the cash, besides taking a 401(k) loan?