Post by Zoinkers on Nov 25, 2006 2:14:28 GMT -5
401(k) from former employer? Be sure to look before you roll over
WHERE ROLLOVERS GO
Where employees roll over lump-sum distributions from a former employer's retirement plan:
Individual retirement account 70.2%
New employer's plan 12.7%
Individual annuity 7.2%
Other 9.9%
Source: Employee Benefit Research Institute
You're just a regular Joe who doesn't have much investment experience. Your idea of a night on the town is dinner at Denny's. Doesn't matter. If you have a 401(k) plan with a former employer, you are hot stuff on Wall Street.
With billions of dollars sloshing around in orphaned 401(k) plans, financial firms are eagerly marketing their rollover individual retirement accounts. Some are sponsoring workplace seminars for retiring or departing employees. Others have launched ad campaigns aimed at aging boomers.
Unfortunately, the potential for big profits has attracted a few miscreants. The New York Stock Exchange's enforcement arm said last week that it has seen an increase in complaints from savers who suffered big losses after their IRA rollovers were invested in high-risk stocks and funds.
And sometimes, rolling over your entire 401(k) to an IRA is simply not a good idea. Two examples:
•Your 401(k) includes a lot of highly appreciated company stock. If your shares have risen significantly in value, you might be better off transferring them from your 401(k) to a taxable brokerage account, and rolling over the rest of your savings to an IRA, says Sarah Hussey, a financial planner in Bridgewater, N.J.
This strategy will allow you to pay ordinary income taxes on the original value of company stock, but then pay a lower capital gains rate on any appreciation.
For workers who have a lot of appreciated company stock in their 401(k) plans, this could translate into big savings.
Suppose, for example, you own company stock worth $400,000 that you bought years ago for $100,000, or received as a matching contribution from your employer.
If you withdraw that company stock and place it in a brokerage account when you do the rollover, you'll owe income taxes on $100,000. The remaining $300,000 will be taxed at the long-term capital gains rate — now 15% for most taxpayers — when you sell your shares.
If, on the other hand, you included the company shares in your IRA rollover, Hussey says, the entire $400,000 would be taxed at your regular income tax rate when you took withdrawals from your IRA. Depending on your tax bracket, that could be as high as 35%.
Keep in mind that this strategy, known as "net unrealized appreciation," applies only to shares of company stock.
And this move makes sense only if your shares are now worth a lot more than you paid for them. Otherwise, you wouldn't get much of a benefit from the lower capital gains rate on the appreciation.
This maneuver is complicated, so it's a good idea to get professional advice before you attempt it.
•You're retiring at 55. Retirees who are 55 or older can take withdrawals from their 401(k) plans without incurring the 10% early-withdrawal penalty, says David Bizé, a financial planner in Oklahoma City. (You'll still have to pay income taxes on any withdrawals.)
If you roll the money into an IRA, he says, you'll have to wait until you're 59½ to take penalty-free withdrawals.
Investing your rollover IRA
For most people, though, rolling over a former employer's 401(k) plan into an IRA is a smart strategy. Your money will grow, tax-deferred, until you take withdrawals. And you'll have more investment options than those offered by your 401(k) plan.
When you roll the money into an IRA, you can invest it just about anywhere: mutual funds, individual stocks, real estate, even precious metals.
But just because you can invest your IRA in exotic places doesn't mean you should. You may need to make this money last for 25 years or more. You may want to hire an adviser to help you choose appropriate investments, and many financial firms offer online tools.
But if you're worried about making the wrong choices, consider investing your rollover IRA in a target retirement fund. These funds allocate your investments based on when you plan to retire.
For investors who are already retired, they offer a mix of large-company stock and bond funds.
These funds have caught on with 401(k) plan investors, and they're gaining popularity among IRA investors, too.
Of the $14 billion invested in T. Rowe Price's target retirement funds, about 25% is in IRAs, says spokesman Brian Lewbart.
Whether you choose a premixed IRA or create your own, you should have a diversified portfolio of stocks and funds.
Steer clear of anyone who claims he can produce guaranteed returns or who recommends investing a large percentage of your savings in a single stock or sector.
"If you have a broker who is telling you that diversifying your portfolio is 'old school,' " says Allison Bishop of NYSE Regulation, "that's not a good thing."
Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com.
WHERE ROLLOVERS GO
Where employees roll over lump-sum distributions from a former employer's retirement plan:
Individual retirement account 70.2%
New employer's plan 12.7%
Individual annuity 7.2%
Other 9.9%
Source: Employee Benefit Research Institute
You're just a regular Joe who doesn't have much investment experience. Your idea of a night on the town is dinner at Denny's. Doesn't matter. If you have a 401(k) plan with a former employer, you are hot stuff on Wall Street.
With billions of dollars sloshing around in orphaned 401(k) plans, financial firms are eagerly marketing their rollover individual retirement accounts. Some are sponsoring workplace seminars for retiring or departing employees. Others have launched ad campaigns aimed at aging boomers.
Unfortunately, the potential for big profits has attracted a few miscreants. The New York Stock Exchange's enforcement arm said last week that it has seen an increase in complaints from savers who suffered big losses after their IRA rollovers were invested in high-risk stocks and funds.
And sometimes, rolling over your entire 401(k) to an IRA is simply not a good idea. Two examples:
•Your 401(k) includes a lot of highly appreciated company stock. If your shares have risen significantly in value, you might be better off transferring them from your 401(k) to a taxable brokerage account, and rolling over the rest of your savings to an IRA, says Sarah Hussey, a financial planner in Bridgewater, N.J.
This strategy will allow you to pay ordinary income taxes on the original value of company stock, but then pay a lower capital gains rate on any appreciation.
For workers who have a lot of appreciated company stock in their 401(k) plans, this could translate into big savings.
Suppose, for example, you own company stock worth $400,000 that you bought years ago for $100,000, or received as a matching contribution from your employer.
If you withdraw that company stock and place it in a brokerage account when you do the rollover, you'll owe income taxes on $100,000. The remaining $300,000 will be taxed at the long-term capital gains rate — now 15% for most taxpayers — when you sell your shares.
If, on the other hand, you included the company shares in your IRA rollover, Hussey says, the entire $400,000 would be taxed at your regular income tax rate when you took withdrawals from your IRA. Depending on your tax bracket, that could be as high as 35%.
Keep in mind that this strategy, known as "net unrealized appreciation," applies only to shares of company stock.
And this move makes sense only if your shares are now worth a lot more than you paid for them. Otherwise, you wouldn't get much of a benefit from the lower capital gains rate on the appreciation.
This maneuver is complicated, so it's a good idea to get professional advice before you attempt it.
•You're retiring at 55. Retirees who are 55 or older can take withdrawals from their 401(k) plans without incurring the 10% early-withdrawal penalty, says David Bizé, a financial planner in Oklahoma City. (You'll still have to pay income taxes on any withdrawals.)
If you roll the money into an IRA, he says, you'll have to wait until you're 59½ to take penalty-free withdrawals.
Investing your rollover IRA
For most people, though, rolling over a former employer's 401(k) plan into an IRA is a smart strategy. Your money will grow, tax-deferred, until you take withdrawals. And you'll have more investment options than those offered by your 401(k) plan.
When you roll the money into an IRA, you can invest it just about anywhere: mutual funds, individual stocks, real estate, even precious metals.
But just because you can invest your IRA in exotic places doesn't mean you should. You may need to make this money last for 25 years or more. You may want to hire an adviser to help you choose appropriate investments, and many financial firms offer online tools.
But if you're worried about making the wrong choices, consider investing your rollover IRA in a target retirement fund. These funds allocate your investments based on when you plan to retire.
For investors who are already retired, they offer a mix of large-company stock and bond funds.
These funds have caught on with 401(k) plan investors, and they're gaining popularity among IRA investors, too.
Of the $14 billion invested in T. Rowe Price's target retirement funds, about 25% is in IRAs, says spokesman Brian Lewbart.
Whether you choose a premixed IRA or create your own, you should have a diversified portfolio of stocks and funds.
Steer clear of anyone who claims he can produce guaranteed returns or who recommends investing a large percentage of your savings in a single stock or sector.
"If you have a broker who is telling you that diversifying your portfolio is 'old school,' " says Allison Bishop of NYSE Regulation, "that's not a good thing."
Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com.