Did You Leave a Retirement Plan at a Former Job?

by Bobbie Shocket Lazarz

Did you leave behind a 401(k), 403(b), or 457 governmental deferred compensation plan at a former job--or are you about to? If so, depending on your situation and assuming you're not ready to retire, you generally have four options for your savings.

Before making any moves, contact your plan administrator and, if necessary, a financial or tax adviser for complete information about the rules and tax consequences.

Option 1: Leave your savings with your former employer.

You may be able to leave your retirement plan with your former employer. However, if your balance is $5,000 or less, your employer might require you to take your money.

Before settling on this alternative, review your plan's investments, fees, services, withdrawal restrictions, and distribution rules. Then compare the plan with an IRA (individual retirement account) and, if you have one, your new employer's retirement plan.

For example, the former employer's plan might offer investments not available in an IRA, such as low-cost institutional mutual funds, funds with competitive long-term performance that are closed to new investors, or stable value funds or fixed accounts that preserve your principal. On the other hand, your current employer plan might only have limited investment options.

Option 2: Roll over your plan to a traditional IRA.

Once you've left your employer, you have the option of directly rolling over part or all of the eligible distribution from your 401(k), 403(b), or 457 governmental plan to a traditional IRA. Rolling over your plan allows your savings to continue accumulating tax-deferred.

A traditional IRA may offer you a broader selection of investment options than your current or new employer-sponsored retirement plan. Specifically, IRAs allow you to invest in most types of savings and investments, including CDs/share certificates, Treasury securities, mutual funds, and individual stocks and bonds.

And if you have an existing IRA or other accounts, consolidating your retirement savings with one provider streamlines your paperwork, makes it easier to develop and maintain your investment plan, and simplifies your required minimum distribution calculations when you reach age 70�.

A traditional IRA also may offer you and your beneficiaries more flexible and tax-favored distribution options than your employer retirement plan. For instance, an employer plan may require nonspouse beneficiaries to take inherited money in an immediately taxable lump sum, with no option to instead have it distributed over their lifetimes.

Furthermore, if you're still working, you can make new contributions to a traditional IRA until age 70�. Traditional IRAs, however, don't offer loans, as may any new employer plan you have.

Rolling over your employer plan savings to a traditional IRA also gives you the option, if you're eligible and after paying any income taxes due, to convert your savings to a tax-free Roth IRA. (You cannot roll over savings from your former employer's plan directly to a Roth IRA. The IRA specialist at your credit union can explain how to make the conversion.)

Option 3: Move your savings to your new employer plan.

If you have a 401(k), 403(b), or 457 governmental plan with a former employer, you can roll over eligible distributions tax-free to any such plan that accepts rollovers.

For example, if you left your teaching job and went to work for a private company, you can roll over your 403(b) savings to a 401(k) plan that accepts rollovers. Or if you left your government job for a job with a nonprofit organization, you can roll over your 457 governmental plan savings to a 403(b) plan if your new employer has this type of plan that accepts rollovers.

When considering the alternatives, compare your new employer retirement plan with your current plan and an IRA. Evaluate the investments, services, withdrawal restrictions, loan provisions, distribution options, and fees.

For example, your new employer plan might have only limited investment options. In that case, your current employer plan or an IRA might offer a broader selection of investments.

Option 4: Cash out and pay taxes.

As a last resort after you've left your job, you can withdraw part or all of the vested portion of your employer-sponsored retirement plan. If you do, you'll lose a significant chunk of your savings to federal income taxes, possibly state income taxes, and possibly to the 10% early withdrawal tax penalty.

In addition, your employer must withhold 20% up front as prepayment for the federal income taxes you'll owe at tax filing time. You'll also lose out on future years of earnings and tax-deferred growth.

Make your best effort to keep your retirement savings intact and carefully consider all your other options before making this irreversible move.

Bobbie Shocket Lazarz, Certified Financial Planner Professional TM, MSW, MBA, has been educating credit union members about personal finance for 15 years.

July 31, 2006