In the last 18 months many Americans have been faced with job loss. The economy is so slow that finding work is not easy. For those people a 401k rollover to an IRA was and is the only good option for their retirement account. When you leave a company, you have the option to roll your account into a new 401k at a new company, put it in an IRA or Roth IRA or leave it where it is. For so many people the second option is not only the best option; it’s the only option.
While you could leave the money in the existing 401k account, that is a bad move. When financial times are tough, it is hard to know what the 401k rules are. Make it easy on yourself and put the money into an Individual Retirement Account. There are so many things to worry about when you are abruptly leaving a company. Your emotions are a storm and you will not make the soundest financial decisions right now. Better to take a straightforward path and have the money removed from any connection with your old company. It’s not as though they will do anything bad with the money, but once you are on your feet again, you want all of your retirement money working for you in one account. A 401k rollover to IRA will ensure that all your money can be in one place.
410ks make it easy to save for retirement and a rollover will make it easy to get momentum back, when you are back on your feet. I want you to avoid some common 401k rollover mistakes. The most common mistake, by far is leaving the money where it is. Some people think that requesting a rollover sends the wrong signal to the company. They want to keep the door open for reemployment and think that moving the 401k account will make the company think twice about rehiring. It could be that you will end up back with that same company, but the statistics are against you there. In my mind, the bigger issue is would you want to work for a company that was that petty? It is your money! Take it with you.
Why does it matter so much? If you leave the money in the existing 401k account it will never reach its potential for two main reasons.
1. You are no longer adding money to it. It’s like a tree that never gets water.
2. The fees will chip away at the money. Yes, the money will grow. Slowly. And it will be hampered by account fees. In a healthy retirement account, the growth easily overcomes any hit the fees would make.
Another common mistake, especially these days, is cashing out the account. Some people, when faced with job loss choose to take the money instead of doing the rollover. I can understand the temptation; really I can. But like most tempting things, it’s not good for you! Again there are two main reasons to avoid this mistake.
1. You take a serious tax hit right now. If you cash out your 401k, you have a 10% penalty and then, on top, you pay taxes on the money. Let’s say you have $20,000 in your 401k. The penalty makes it $18,000 and the taxes will probably take another $6,000. So you just spent $8,000 to have $12,000 in hand. Some of you are nodding vigorously. You don’t see any problem with my math.
That leads us to problem 2. You are adding years to your work life. Do you have any idea how much oomph $20,000 has if it is invested? Do you know how much it can grow, given 10, 15 or 20 years? If you leave that money alone today, you can probably retire 5 years sooner than if you cash it out. That is how much the money will grow if left alone.
$12,000 in hand or 5 years of your life behind a desk — your choice.