A new job means tough choices over 401(k) accounts, but help is on the way

When Koree Khongphand-Buckman went to work at Deloitte & Touche last year, she faced a common dilemma: what to do with the money in the 401(k) retirement account she had left behind at her former employer?

She had several choices, but the 25-year-old senior marketing coordinator quickly decided to transfer the money to the 401(k) she had established at Deloitte.

“My husband is an accountant,” the Port Washington, Wis., resident explained. “He told me I had to do it.” The couple liked the convenience of having the money all in one place.

Deciding what to do with old 401(k) accounts is an important decision.

Under the law, there are four possible options for a 401(k) parked at a former employer: Leave the money in the existing account; withdraw it and pay taxes on it; roll it over to the new employer’s 401(k); or move it to an Individual Retirement Account.

Most 401(k) plans offer these options, but not all. The law provides considerable leeway to sponsors, so it pays to check the provisions of a particular plan.

Named after the section of the Internal Revenue Code that regulates them, 401(k)s are similar to IRAs: Money contributed grows on a tax-deferred basis until withdrawn. Unlike an IRA, however, both employers and employees can contribute to 401(k)s in pretax dollars. Typically, sponsoring companies offer a limited range of investment options.

About 45 million Americans have 401(k)s, up from 37 million in 1998.

Much of their appeal is linked to their portability: 401(k)s are attached to the individual, not to the employer. That is in contrast to traditional pensions, which were set up and maintained by one employer even after a worker moved on to another company.

Now, though, many people change employers frequently. According to a recent study by the U.S. Census Bureau, people born between 1957 and 1964 are likely to have more than 10 jobs prior to retirement. In such a mobile society, few workers will hang around long enough to accumulate a large traditional pension from any one employer. Meanwhile, they are likely to amass 401(k).

That is when people are faced with the decision about what to do with their collection of accounts.

Typically, employers do not want to babysit low-balance accounts owned by former employees. Often, plans specify they will not keep account balances of less than $5,000 for former employees. In such cases, the former employer can force a worker to either move the money to an IRA or new 401(k) or to withdraw it and pay the required taxes. In most cases, that translates to regular income tax rates plus a 10 percent federal penalty.

In coming months, however, the standard will change. Under regulations being developed by the IRS and U.S. Labor Department, if a former employee does not make a choice, the money will be deposited in an IRA, said John E. Donahue, a partner in the Milwaukee law firm of Godfrey & Kahn who specializes in retirement plans.

Moving the money from an old 401(k) to an IRA usually is the best plan in any event, even for those with balances of more than $5,000, according to Reb Bortz, a financial planner in Brookfield, Wis.

“Unless there are extraordinary circumstances, and by that I mean disability, absolute medical emergency or some sort of financial crisis, the ideal solution is to do a rollover to an IRA because an Individual Retirement Account owner has an almost unlimited choice as to where that money can go,” Bortz explained. “If rolled into the new employer’s 401(k), they are required to use the investments that are inside that plan.”

The disadvantages are most IRAs charge an annual fee and commissions often must be paid to invest the money. 401(k) sponsors pick up such costs for their plans.

There also is additional record keeping involved in keeping track of an IRA, especially if the person also participates in the 401(k) at their new employer, as financial planners advise.

Some people are reluctant to move money out of a 401(k) if they’ve lost on the investments it holds. They hope it will rebound before they roll the funds into a new account.

Because there is no penalty for transferring the money into the new account, however, it is smart to do so and then put it in a similar investment to see if it will then rebound.