Between an already sluggish economy and the financial shockwaves from the recent credit crunch and bad housing market, many businesses are cutting expenses by letting workers go. Even if these events haven’t affected your company directly, odds are you know someone who has been laid off. A big decision faced by newly-unemployed workers is what to do with their company retirement accounts. When someone loses a job and needs cash immediately to pay the bills, it can be real tempting to cash out of the old employer’s retirement plan right away. My advice: resist temptation.
When you terminate employment, there are essentially three choices for your retirement money. One, leave the money where it is (in the ex-employer’s retirement plan). Two, cash out the plan and pay the taxes (and potential penalties). Or three, roll the money into an IRA.
Leaving money in an ex-employer’s plan can be a good option, especially if you like the investment choices and the fees/costs are low. But nowadays, you can often easily find those exact same investment choices in an IRA. Odds are you’ll have the same services available to you as offered by your old retirement plan, like quarterly statements, an 800 number to talk to IRA specialists, and web/telephone access to your account. Score one point for the IRA rollover.
If you need cash now or at some point in the future though, cashing out your employer retirement plan is the worst way to go. Your employer will have to withhold 20% of your money on any money you withdraw. If you roll this money to an IRA and then cash it out, you’ll avoid the 20% withholding. Plus you can withdraw as much or as little as you need from the IRA, flexibility not usually found in most employer plans. Score another point for the IRA rollover.
Whether you take money directly from your employer plan or from an IRA, any money taken out will be subject to tax (just like a paycheck), and if you’re under 59 ½, you’ll pay a 10% penalty as well. That is the federal government’s way of encouraging you to lay off your retirement account, and find alternative funds instead. But if you find yourself (or someone you know) laid off and unable to find cash elsewhere, the IRA rollover usually gives you more options and control.
Any one choice is not better or worse; it all depends on your circumstances, as always. In general though, you’ll have the most flexibility if you roll your retirement plan money directly into an IRA. And if you’re able to leave your money in an IRA, it will continue to grow tax-deferred until your retirement years.