Options for Your 401(k) When Changing Jobs

For a wide array of reasons--including layoffs, early retirements, relocations and attractive career moves--millions of people terminate their current employment each year. If you are among the job-departing masses and you're not yet old enough to retire, you're likely to face tough decisions about your 401(k) plan.

Over the past several years, 401(k) plans have become the pension plan of choice for the bulk of the nation's employers. More than half of all employers now offer them. At big companies, you're more likely to get a 401(k) plan than an annoying supervisor. Better than 9 out 10 of the Fortune 500 have one.

Among the reasons 401(k) programs have become so common is because they are cheaper to administer than traditional pension programs and companies do not have to worry about the investment of pension funds. They also help solve one of the most troubling issues of traditional pensions--portability. Traditional "defined benefit" pension plans simply go up in smoke when you change jobs too quickly.

With the 401(k), when you leave, you can take your pension with you. The question is, do you want to?

In essence, when you leave a job where you had a 401(k) plan, you're confronted with four possible options, says Rich Koski, benefit consultant with Buck Consultants in Secaucus, N.J.

If you have more than $3,500 in the plan, you can leave the money in the former company's plan; you may be able to transfer it into the new company's 401(k) plan; you can always transfer it into a so-called "rollover" Individual Retirement Account, or you take the cash and spend it.

The best option for you will depend on a variety of factors. Only one choice--to take the money and spend it--is universally bad, says Norbert H. Chung, assistant vice president with Johnson & Higgins in Los Angeles. That's simply because the government exacts such hefty taxes and penalties that what's left is hardly worth spending.

To be specific, Uncle Sam taxes pre-retirement distributions from a 401(k) at your ordinary income tax rate, and adds a 10% federal tax penalty. States that impose income taxes usually have similar rules, so if you live in a high-tax state, such as California, Hawaii, Iowa, Montana, North Dakota, Oregon or Washington, D.C., you could lose a fortune.

Consider a hypothetical consumer--Jonny Jobchanger, who earns $30,000 annually and had $10,000 in a 401(k). He's taking a new executive position and wants to use the $10,000 as a down payment on a new Corvette. But federal taxes consume $3,800 of Jonny's account value. Because Jonny lives in Los Angeles, he's also subject to California's state taxes and penalties. They gobble up another $1,136. In the end, he's left with just $5,064 of the original $10,000--barely enough to pay the Corvette's annual insurance premium.

So unless you have nowhere else to turn, it is best not to spend the money.


The other 401(k) options are a bit trickier.

For instance, if you have more than $3,500 in your 401(k) you can leave it where it is but the law doesn't require the company to treat you like they did when you were still an employee. For one thing, where many companies allow employees to borrow from their own 401(k) accounts, few permit borrowing after you've left the company's employ. Indeed, if you have an outstanding loan when you switch jobs, you've probably got to pay it off immediately. If you don't, the company will simply report it as a taxable pension distribution--and you know what happens then.

If the new company would allow you to borrow from your old 401(k) funds, switching probably makes sense. But make sure it is allowed--companies segregate transferred funds and may treat them differently.

Switching it to the new company plan also depends on whether you like the investment options better there. Most likely, you'll have a different group of mutual funds to choose from, so just to keep your investments diversified you might want to keep the old funds while investing in the new, as long as you don't mind keeping track of extra statements and accounts.

A few companies may offer nothing more than a company-stock plan, which can be highly unattractive if you happen to take a job with a financially shaky firm. Just ask employees of the Broadway what happened to their stock ownership plan when the company filed bankruptcy for the second time.

Once you transfer money into the new company's 401(k) it's nearly impossible to get the money out without quitting your job or taking a taxable distribution, Chung says. If you're unsure of the new plan, don't transfer 401(k) money in, Chung adds.

What about a rollover IRA? Your investment choices in a rollover IRA are nearly unlimited, because you can set these up at most banks, brokerages and mutual fund companies. They're easily transferable from one institution to another, too. The only problem is you lose your ability to borrow from the account.

Once you put 401(k) distributions into an ordinary rollover IRA, you also can't transfer the money back into a 401(k) program later. If, on the other hand, you leave the money in the old company's plan, you can opt to have it transferred to another company's 401(k) at any time.

There is one other option, however. When you roll money into an IRA, you can ask that it be put into a so-called "conduit" IRA, says Chung. In most respects a conduit IRA is like any other. The main difference is you can't add money to it--unless the money is from another qualified retirement plan. Because you don't mingle 401(k) funds with IRA deposits in a conduit IRA, you can transfer the money that's in a conduit IRA into a 401(k) at a later date, too.

Kathy M. Kristof welcomes your comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls. Write to Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or message kristof@news.latimes.com on the Internet.

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