THE JOURNAL & TOPICS NEWSPAPERS | WEDNESDAY, APRIL 19, 2006
Preserving Your Assets When You Change Jobs
This Way To Wealth, By Alan Friedlander
Your earning power - your ability to earn an income - is your most valuable asset. Few people realize that a 30-year-old couple will earn more than two million dollars by age 65 if their total family income averages $75,000 for their entire careers, without any raises.
Once retirement is reached it does not matter how much you earned during your working years. What does matter is how much money you have saved, accumulated, and what you choose to do with those funds during retirement.
The biggest financial risk that anyone faces during retirement is the risk that savings will be depleted - the risk that income will be outlived.
When you change jobs, you may have an important decision to make: What to do with your money in an employer-sponsored retirement plan, such as a 401(k) plan. Since these funds were originally intended to help provide financial security during retirement, you need to carefully evaluate which of the following options will best ensure that these assets remain available to contribute to a financially secure retirement.
Take the funds: You can withdraw the funds in a lump sum and do what you please with them. This is, however, rarely a good idea unless you need the funds for an emergency because of the mandatory 20 percent federal income tax withholding subtracted from the lump sum you receive. You may have to pay additional federal (and possibly state) income tax on the lump sum distribution, depending upon your tax bracket (and the distribution may put you in a higher bracket).
Unless one of the exceptions is met, you may also have to pay a 10 percent premature distribution tax in addition to regular income tax. The withdrawn funds will no longer benefit from the tax-deferred growth of a qualified retirement plan.
Leave the funds: You can leave the funds in your previous employer's retirement plan, where they will continue to grow on a tax-deferred basis. If you're satisfied with the investment performance/options available, this may be a good alternative. Leaving the funds temporarily while you explore the various options open to you may also be a good alternative. If your vested balance in the retirement plan is $5,000 or less, you may be required to take a lump-sum distribution.
Roll the fund over: You can take the funds from the plan and roll them over. They can be rolled either to your new employer's retirement plan if the plan accepts rollover, or to a traditional IRA. You will have more control over investment decisions in the IRA. This approach offers the advantages of preserving the funds for use in retirement, while enabling them to continue to grow on a tax-deferred basis.
Many financial planners, economists, and others will recommend the rollover. An IRA rollover can be used with a qualified plan distribution in one of two ways:
* As a qualified plan conduit: The qualified plan distribution is transferred to an IRA rollover, where it is held and maintains its tax-deferred status until it is transferred into the retirement plan of a new employer, assuming the new plan allows it.
* As a retirement accumulation vehicle: The qualified plan distribution is transferred to an IRA rollover, where the funds are invested and enjoy tax-deferred growth in a traditional IRA until needed for retirement income purposes.
Bankruptcy protection: The funds in an employer-sponsored retirement plan are protected from the reach of creditors in the event of a bankruptcy. Whether IRA assets enjoyed this same protection has been questionable. With the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, however, effective October 17, 2005, up to one million dollars of traditional and Roth IRA assets in the aggregate become protected from bankruptcy creditors. The one million-dollar exemption does not apply to rollover IRA assets, which retain their unlimited exemption. For this reason, it is generally preferable to segregate rollover IRA asserts in a separate IRA account. Remember to consult your tax and financial advisor for specific advice about your situation.
Alan S. Friedlander owns a financial services practice in Gurnee, IL. If you have specific questions, feel free to contact him directly at 847-855-4888.