Thursday, June 7, 2007

Don't Unretire Your Retirement Savings

Legend has it that there was once a time when gasoline cost 35 cents a gallon, mortgage payments were $200 a month, and people pursued a career by getting an education or training in a field, finding a job with a good employer, and staying there for 30 or 40 years until they retired with a pension and a watch. Some of the legend is true--gasoline once did cost 35 cents a gallon and mortgage payments for many people were $200 a month, or even less (but they had to watch flickering black and white TVs). Spending one's entire working life at one employer was, in those days, probably more the exception than the rule. But the availability of defined benefit pensions (which promised a predictable amount of money in retirement) made doing so worthwhile.

Today, most people work for a half-dozen or more employers during their working lives, and the defined benefit pension is about as common as the brontosaurus. They usually don't work long enough at any one employer to qualify for a pension, and if they do, it generally isn't much of a pension. (Some companies have changed traditional defined benefit pensions to "cash balance" plans that supposedly favor newer employees but hurt the interests of long time employees; so don't think loyal and faithful service mean much.)

Today's way of funding retirement is the retirement savings account, such as 401(k) plans, IRAs, etc. Originally, these accounts were meant to supplement traditional pensions. But now, with defined benefit pensions going the way of the carrier pigeon, retirement savings accounts--especially the 401(k)--have morphed into the only show in town for a lot of workers. They have tax advantages. But you can wreck your retirement plan every time you change jobs.

That's because every job change gives you an opportunity to withdraw the money in your 401(k) account. If you do, you'll have to pay federal and state income taxes on the amount withdrawn and also a penalty of 10% if you're younger than 59 and 1/2. Depending on where you live, you could lose half or more of the funds withdrawn. Even if you put the remainder in a taxable savings or investment account, its earnings will be taxed currently. So you lose the boost to your savings from compounding earnings on a tax deferred basis. Of course, if you spend the money, it's gone forever.

When you change jobs, don't withdraw the money in your 401(k) account. You'll have one or more of these options: (a) leave it in your old employer's 401(k); (b) roll it over into an IRA; or (c) roll it over into a 401(k) plan offered by your new employer). Compare the fees and expenses of these options, and the investment alternatives. Then pick the option that gives you the best combination of low fees and expenses, and good investment alternatives. If you have a small 401(k) balance with your old employer, it may not allow you to stay in its plan and may issue you a check for the balance. Be sure to contribute that money into an IRA or your new employer's 401(k) plan within 60 days. If you meet the 60 day deadline, you won't have to pay taxes or a penalty.

Let's say you change jobs 8 times during your adult working years. If you withdraw your 401(k) money each time, you'll have only Social Security and whatever savings you've accumulated in taxable accounts. If you keep the money in one retirement account or another, you'll have compounded your way to what will probably be a nice supplement to your retirement. (We discuss the power of compounding at Resist the temptation to spend retirement savings just because you can. All of your retirement days will be long if you're trying to make a go of it on just Social Security.

Tech News: A new use for ring tones: attracting leopards. Just don't leave your cell phone on in the jungle.

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