The Retirement Corporation of America

The Special Rules About Moving Money Around

LIFE WAS EASY in the "good old days." You worked for one company all your working life. You were provided with a defined benefit (DB) pension plan by your employer. All the decisions about managing that pension plan were made by your employer. When you retired, the pension was paid to you—either in a lump sum, or in periodic payments from an annuity. None of that involved a great deal of decision-making on your part.

Well, as you know, life is a lot more complicated now. You may still have a DB pension plan at work, created and managed by your employer. But you may also have a defined contribution (DC) pension plan, such as a 401(k) plan. Or you may only have a DC pension plan, with no DB plan at all.

If you are covered by a DC pension plan, you have some decisions to make.

•  While you are working, you must make all your own investment decisions. How well your pension pays off at retirement depends, in a large part, on how successful you have been as an investor during your working life.

•  When you leave the company—at retirement or to move to another job—you have to decide what to do with your DC pension plan.

Here Are Your Options

What to do with your 401(k) DC pension plan:

•  Option #1: Take the money out of the plan in the form of cash. You'll have a lot of spending money to do with as you want. But you'll pay taxes on the money withdrawn. If you haven't reached 59 1/2, you may owe a 10 percent penalty as well. Worst of all, the money is no longer compounding, tax-sheltered, to help pay for your retirement.

•  Option #2: Move your 401(k) account to the DC pension of your new employer. This would only apply if you changed jobs, rather than retiring. Also, not all employers will let you move money from your old plan into the new plan.

•  Option #3: Roll the money into an IRA—traditional or Roth. You keep your retirement nest egg intact and tax-sheltered. You can invest the money in mutual funds or let a bank or other investment professional manage it for you. Or you could open a brokerage account and invest the money directly in stocks and bonds.

•  Option #4: Roll the money into an annuity. You keep your retirement nest egg intact, and you keep it tax-sheltered as well. Then you can begin collecting a stream of payments right away or at some point in the future.

How To Handle the Rollover So You Don't Get Hurt

Obviously you don't want to try Option #1. And Option #2 may not be open to you, unless you are moving to a new job that also offers a 401(k) plan.

That leaves Option #3 or Option #4. Either one makes a lot of sense if you will need the money fairly soon. Option #3 is your best choice, with the money rolled into a Roth IRA, if you won't need the money for at least five years.

However, it is easy to get into trouble here. You can't just do things willy-nilly and hope for the best. The IRS has some very strict rules about a 401(k) rollover. Here are the chief pitfalls to avoid:

•  Pitfall #1: The rollover must be completed within 60 days of leaving your company unless otherwise specified in your 401(k) plan. Otherwise, the IRS will consider it a withdrawal and you will owe taxes.

•  Pitfall #2: The administrator of your 401(k) plan must send your money directly to the broker or mutual fund that will administer your rollover IRA. If you ask to have the balance sent to you, your employer will withhold 20 percent, and you'll get what's left. If you do complete the rollover within the sometimes-required 60 days, you can ask to have the 20 percent refunded the next time you file a 1040 tax return.