• October 2013

Spender Beware: 7 Do's and Don'ts for Taking Money Out of Your Retirement Accounts

By Sheldon Weiner
Financial Adviser
Partner, Egan, Berger & Weiner
Email: sweiner@ebwllc.com

If you just got a new job, or are about to retire after a long and successful career—then congratulations!

After the champagne and festivities, be sure to turn to the important decision of what happens to your defined contribution plan with your former employer.

Here are seven do’s and don’ts:

1. Do not cash out.

Sure, it’s tempting. And, according to a 2009 survey by the human resources consulting firm Hewitt Associates, nearly half of employees cashed out their 401(k) balance when they moved to a new job. But it’s a big mistake.

Here’s why: Not only will you pay taxes on all that cash—plus a 10 percent early withdrawal penalty if you’re under 59 ½—but you’ll lose out on future compounding and growth from leaving it in a 401(k) or rolling it over to an IRA.

For instance: Say you cash out $200,000 from your 401(k) at age 45 and you are in the 28 percent tax bracket. After paying $56,000 in taxes and $20,000 in penalties, you will have managed to whack your nest egg. If you don’t cash out and instead achieve a 7 percent growth rate a year, at age 65 you will have accumulated nearly $774,000. (This example is hypothetical only and does not represent the actual performance of any particular investment. Investments in securities do not offer a fixed rate of return. Principal, yield, and/or share price will fluctuate with changes in market conditions, and, when sold or redeemed, you may receive more or less than originally invested.)

2. Do consider whether or not to leave the funds where they are.

Here’s why: While it may seem attractive to do nothing and let your current retirement plan stay where it is, sometimes this may be unwise. It may make sense to leave funds in a 401(k). For example, a client between the ages of 55 and 59 ½ who closes a 401(k) has access to that money penalty-free. If they roll it into an IRA, however, it will be locked up until after the client reaches 59 ½ or another trigger event.

But remember: Just because you have left an employer doesn’t mean that you can’t re-allocate the funds in that account. It’s still your account—not your employer’s! Likewise, if a company you used to work for goes out of business, that doesn’t necessarily mean the investment company that held your retirement funds also went out of business. The money in that account is still yours.

3. Do watch for balances under $5,000.

Here’s why: At some firms, if you have less than $5,000 accumulated, the company will automatically distribute the money to you and take out the 20 percent tax they are obligated to withhold for the IRS.

4. Do make sure any checks to you are made out properly.

When you transfer your money, be sure that the check is made out to your new plan—and not to you personally—and that you are engaging in a trustee-to-trustee transfer. Better yet, have your old investment company wire the money directly to your new fund company.

Here’s why: If you don’t do this, your ex-employer will have to withhold 20 percent for taxes, and possibly will take a 10 percent additional charge if you are under 59 ½. If that’s the case, you’ll be in the same position as if you did a cash out.

Note: You may have to replace the 20 percent out of your own pocket. Fortunately, the IRS will pay you back when you file your next tax return—but with zero interest.

5. Do check to see if you have company stock in your plan.

Normally, if you roll over company stock into an IRA, you’ll owe steep ordinary income taxes on that money when you eventually withdraw it.

The better option: If you take a payout of the company stock now, you’ll owe capital gains tax and perhaps an early withdrawal penalty—but just on your original purchase price of the stock. You’ll also pay at lower capital gains tax rates, which are currently 15 percent.

Note: This strategy is called net unrealized appreciation, or NUA—the difference between your original price, or cost basis, and the present market price.

6. Do look into a Rollover IRA.

In some cases, a rollover IRA can be a better option than leaving the money in your old 401(k) or transferring it to a new employer’s plan.

Here’s why: Fees may be lower and you may have many more investment options. There are also more ways to avoid a withdrawal penalty with an IRA compared with a 401(k). For example, you can withdraw money from your IRA without penalty as a first-time home buyer, for higher education, and for health reasons.

Note: You do not have to prove financial hardship as you do on many 401(k) plans, plus you’ll owe taxes on the withdrawal and a possible 10 percent penalty. (Rollover assets may be subject to an IRA 10 percent premature distribution penalty tax. Consult your own legal and tax advisors regarding your situation. Please carefully consider the benefits of existing and potentially new retirement accounts and any differences in features.)

7. One caveat.

In the coming year, you may not want to roll over your 401(k) into an IRA if you plan to convert any of your IRAs into a Roth IRA.

Here’s why: Normally, high earners cannot contribute in 2013 if their earnings are more than $187,999. Otherwise you will face an unnecessary tax bill.


About Sheldon L. Weiner, LUTCF

  • Founding partner of Egan, Berger & Weiner, LLC
  • 36 years of experience in the financial industry
  • Attended the University of Maryland and the Hartford Insurance Company School of Advanced Underwriting
  • Earned the LUTCF designation (Life Underwriters Training Council Fellow)
  • Served as president of Creative Financial Programs, Inc.
  • More than 10 years of experience as a teacher and lecturer for various educational institutions in the area
  • Active member of the Financial Planning Association (FPA)

Sheldon Weiner resides in Olney, MD, with his wife, Sharon. They have two grown children and three grandchildren. Weiner is active in his community; he has served on several boards of directors and has worked with a number of fundraising groups. He has also been an active member of the Masons, Eastern Star, and The Order of DeMolay, where he achieved the rank of Chevalier.

Contact Weiner by email at sweiner@ebwllc.com.

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