When you leave a job, what do you do with your old 401(k)?
Some 43% of people take a cash distribution from it, according to Aon Hewitt, which is a leading employee benefit plans administrator.
That number has held remarkably steady over the years; 45% of workers leaving a company in 2007 opted for the cash distribution, too.
Some things about human nature never change. But when you're ready to move on from your current employer, there's a smarter move to make instead of treating your 401(k) like an ATM that keeps spitting out $100 bills!
Choose wisely when it comes to your old 401(k)
When hard economic times hit — either in your personal economy or in the larger economy — people are tempted to raid their retirement savings without fully understanding the repercussions.
If you do choose to cash out your 401(k), you’ll typically get hit with taxes and penalties that can eat up some 40% of your money.
For example, if you take a 401(k) with $10,000 in it and cash it out, you get a tax bill for 20% upfront. Then when you file your tax return the following year, you get hit with another 20% or so in taxes and penalties.
That means your $10,000 becomes more like $6,000 and you have zero saved for retirement.
Most financial experts have a bias against you cashing out your retirement account when the going gets tough.
The only times you should even think about doing it if you’ve absolutely exhausted every other resource and can’t put a roof over your head or food on your family’s table.
What should you do instead?
Consider leaving it with your employer’s old plan
By law, you can leave your account balance in your former employer’s 401(k) plan if you hit a certain threshold — $5,000.
But if you’re considering this option, you’ve got to determine one critical piece of info…
Is the plan being administered by a low-cost provider? Money expert Clark Howard likes companies such as Vanguard, Fidelity, T. Rowe Price, in addition to a few other players.
All of these companies offer extremely low costs on all types of investing. In that case, it’s OK to park your money at your old employer’s plan.
Do a trustee-to-trustee transfer
If you’re going to roll a 401(k) over to another retirement plan, you’ve got to do it the right way.
Be sure you’re doing what’s called a “trustee to trustee transfer” when you move the money. That means the money goes from your current plan administrator to your new plan administrator and never touches your hands.
You never want to receive a check for it yourself — even if you go ahead and deposit in a new retirement account — unless you want to be eaten alive on taxes and penalties.
Again, be sure you’re rolling over to a provider with low fees who serves you in a “fiduciary” role. Being a fiduciary means the provider must work in your best interest, not steer you toward investments that pad their own pockets.
Speaking of padding pockets, Wells Fargo is in trouble again — this time for allegedly steering 401(k) rollover money into proprietary investments that don't meet suitability requirements for their clients.
The top securities regulator in Massachusetts has opened an investigation into the allegations against the maligned bank.
It's just another reminder why Clark has long said that you should never do your investing at a bank!