401(k) at old job? Don't cash out!


One of the biggest weaknesses of 401(k) plans is that they allow workers to cash out when they change jobs. Nearly half of all workers cash out 401(k) savings when they change jobs even though they have to pay personal income tax and a ten percent penalty for early withdrawal.

Most of the workers who do cash out are younger workers with smaller balances. Many of these folks figure it's a small amount of money not worth the trouble saving. But over time, cashing out even small balances can have a significant impact on a worker's ultimate retirement savings. Typically workers change jobs five to seven times before they settle into a long-term job, and if they cash out a small 401(k) account every two years, they could be cashing out their retirement savings with nothing to show for it after ten years.

The best option, which is available in many plans, is to transfer your 401(k) plan account from a previous employers plan into your new employer's 401(k) plan. This of course assumes that the new employer's 401(k) plan is as good as or better than the previous plan. If your new employers' 401(k) plan does not permit plan-to-plan transfers, then consider either leaving the balance in the old plan or roll it over to an IRA. Either way, you can continue to invest and grow your retirement savings.

Save Your Retirement Assets

Anyone who has participated in a 401(k) plan and changed jobs has confronted the question of what to do with their account. The most common practice (second of course to cash payments) is to direct a distribution from the plan to a rollover IRA.

But workers should also keep in mind that if your 401(k) balance is above $5,000, you cannot be forced out of a 401(k) from a prior employer. So instead consider either transferring your existing account to your new employer's 401(k) plan or leaving your money in your existing plan, because doing so may have several advantages, including:

-- Lower investment fund fees

-- Investments that are not otherwise available in IRAs

-- Access to online tools and account management services

But if you do choose to rollover your 401(k) to an IRA, then here are the basic steps to do it and avoid triggering a taxable distribution:

-- Open a rollover IRA with a brokerage or a mutual fund company

-- Instruct your prior plan's administrator to make the distribution payable directly to your new rollover IRA, as custodian for your benefit

-- Do not elect to have any taxes withheld from the distribution as it will be tax-free

If your plan will only send a check to your address, include your new IRA number on the check and forward it to your rollover IRA within 60 days of receipt of the check. "Receipt" typically means the post mark date on the envelop in which the check was mailed to you.

If you made Roth type contributions to your 401(k), you will also need to open a Roth IRA, and deposit the Roth source portion of your 401(k) into it.

Remember, spouses are legally entitled to a portion of benefits accrued under an employer's retirement plan. The spouse must consent in writing to allow the account owner to rollover the 401(k) to an IRA. This requirement does not exist for transfers between IRAs. Chose an IRA provider carefully, making sure that they provide the investment flexibility and access you need today and as your balance grows in the future.

Today's worker should have a 401(k) and a Rollover IRA to preserve and build their retirement assets.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.