Four options for your 401(k) when you leave work.
Here’s a question from a listener named Binh:
I need some advice on my 401(k) account. I am in my early 20s. I just resigned from my job and moved to Asia. I wonder what’s the best thing to do with my 401(k) account? I only have about 1,000 dollars in it.
Thanks, Binh. I appreciate your question! One of the great features of workplace retirement plans, such as the popular 401(k), is that they’re portable. That means you can take your money with you when you leave a job. Before I give you the options for what to do with your 401(k) money, I’ll give you a brief overview of the three different types of 401(k) plans. The type of plan you have, the terms of the plan document, as well as how much the investment has gained or lost, will determine the actual amount of money that you can take with you.
What are the Different Types of 401(k) Plans?
The three different types of 401(k)s are the traditional, safe harbor, and SIMPLE plans. Each one allows an employer to deduct money from your paycheck, before taxes are taken out, and send it to your retirement account. All three 401(k) types also allow your employer to contribute company money to your account. That could be done as matching funds or profit sharing funds, for example.
Traditional 401(k) Plans
So let’s discuss how the three plan types are different. With a traditional 401(k), an employer can create a vesting schedule for the contributions they make to your account. A vesting schedule is simply a timeline that shows how long you have to work for a company before you’re legally entitled to the money they’ve contributed for you. A typical vesting schedule could be something like 20% after two years of service, 40% after three years of service, and on up to 100% after 6 years of service. So, let’s say you’ve worked for a company that has this vesting schedule for two years. During that time you contributed $2,000 and your employer contributed $1,000 in matching funds. No matter what type of 401(k) you have, you’re always fully vested in the money that you contribute from your paycheck. So you would be allowed to take your money ($2,000) plus your vested portion, which is 20% of $1,000, or $200. So that totals $2,200, plus any investment gains or minus any investment losses on those amounts.
Safe Harbor 401(k) Plans
The second type of 401(k)—the safe harbor plan—is similar to a traditional plan, except that it doesn’t allow for vesting schedules on company matching. (Some plan documents may implement vesting for profit sharing funds, however.) Matching contributions provided by the employer are fully vested when they’re made, therefore an employee can consider them safe. No matter how long you work for a company, with a safe harbor plan you are entitled to 100% of all company-matched funds in addition to your own funds, plus or minus investment gains or losses. For both safe harbor and traditional 401(k) plans, an employee can contribute up to $16,500 for 2009. For those aged 50 and older, you can contribute an additional $5,500.
SIMPLE 401(k) Plans
The last type of 401(k) is the SIMPLE plan, which stands for Savings Incentive Match Plan. However, it actually is a simpler plan for an employer to administer. Paperwork requirements and regulations are greatly reduced as compared to those of traditional and safe harbor plans. SIMPLE plans were created especially for smaller businesses with fewer than 100 employees. The tradeoff is that it offers the least financial flexibility for the employer, because they’re legally required to make contributions for all eligible employees. It’s similar to the safe harbor plan, because the employer’s contributions are always fully vested. The maximum you can contribute to a SIMPLE 401(k) for 2009 is $11,500. And if you’re 50 or older, you can contribute an additional $2,500.
What to Do with Your 401(k) When You Leave a Job
Now back to Binh’s question about what to do with your 401(k) when you leave work. Once you’re no longer employed by the company, there are four options. They apply whether you resigned, got laid-off, or were dragged out by office security! Two of the options are great, and two of them are terrible. I’ll start with the terrible ones.
The worst option for your 401(k) money is to leave it with your old employer. That’s because companies can radically alter their retirement plans or even go out of business, and you won’t be in the loop about what’s going on. You might need to leave your money there for a short time, but it's never a good idea to let anyone control your money any longer than is absolutely necessary.
The second bad option for your 401(k) money is to withdraw all or a portion of it out of the plan. If you make a non-qualified withdrawal before you reach the official retirement age of 59½, you’ll have to pay income tax plus a whopping 10% penalty on that amount (check out this episode to find out about situations where an early withdrawal might be qualified and not penalized). Unless you’re facing a severe financial crisis in which you have no other option but to withdraw your 401(k) money, it’s just not worth it!
If you land a new job that offers a retirement plan, a good option is to do a rollover from your old plan into your new one as soon as you become eligible to participate. But if you don’t have a new job in sight, or if you’ll be self-employed, the best option for your 401(k) is to do a rollover into an IRA or Individual Retirement Arrangement. That’s what I’d suggest for Binh. It’s easy to open up an IRA through an online brokerage such as etrade.com or ingdirect.com.
But it’s important to do a retirement rollover correctly--breaking the rules means having to pay steep taxes and penalties. So join me again next week when I’ll give you more specific information and tips about doing a retirement plan rollover correctly.
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I’m glad you’re listening. Chi-Ching, that's all for now, courtesy of Money Girl, your guide to a richer life.
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