Move Your Money From an Old to a New 401(k)?

Dear Dr. Don, I would like your advice to help find the best option for me. I just joined a new company, which has a 401(k) plan but doesn't make matching contributions. In this case, what is the best option -- continuing making contributions to the new plan or open an individual retirement account, or IRA, account and start from there? I am able to transfer the plan balance from my previous employer to the new firm after I've been an employee for six months. -- Roxanna Redeploy

Dear Roxanna, The one thing I would recommend against is transferring the plan balance from your previous employer to the new firm. The reason is that I want you to hold on to the financial flexibility of where and how you invest this money. For me, that means doing a trustee-to-trustee transfer from your old plan into an IRA account or Roth IRA account. You want to do a trustee-to-trustee transfer to avoid mandatory withholding on the distribution out of your old 401(k). If the check is made out to you, you'll be subject to mandatory withholding.

Transferring to a Roth also will trigger a tax bill because you're transferring tax-deferred contributions from your 401(k) into a Roth, which is funded with after-tax dollars. But you may be willing to do that to convert your 401(k) tax-deferred money into Roth IRA money that will be tax-free in retirement. In general, the transfer to a Roth IRA makes sense if you can pay the tax bill with money other than the funds held in your old 401(k) because you've kept the entire 401(k) balance invested for your retirement. When you fund the tax liability out of the 401(k) balance, you're just shifting the tax liability in the account forward and won't materially increase your retirement income.

If you hold company stock in your old 401(k) plan, it's likely you don't want to transfer the stock into an IRA account because you can lose the favorable tax treatment associated with net unrealized appreciation. If you're in this situation, work with a tax professional in deciding how to transfer the money out of your previous employer's 401(k) plan.

Going forward with the decision to fund your new 401(k) plan, a traditional IRA or a Roth IRA will depend on how much money you contribute annually toward your retirement. If you're younger than 50, your annual contribution limit to a traditional IRA or a Roth IRA account is the lesser of earned income or $5,000. You can always contribute to a traditional IRA, but if you contributed to an employer's retirement plan in the current tax year, those contributions may not be tax-deferred. There also are modified adjusted gross income limits for the tax deductibility of IRA and Roth IRA contributions.

If you plan to contribute more than $5,000 this year or $6,000 if you're older than 50, then I'd suggest starting to contribute to your employer's 401(k) plan. That may not be likely for the 2011 tax year, so look at adding to the IRA account or Roth IRA account that you paid into at your previous employer's 401(k) plan. In future years, you can let your planned contributions be your guide.

You have three options in doing a trustee-to-trustee transfer into an IRA or Roth IRA account. The transfer can fund a brokerage account, a bank account or an investment with a mutual fund family. Which one is right for you depends on what you're looking for in investment options as well as the fees and costs associated with those account and investment choices. There are no-cost IRA brokerage accounts available, no-load mutual funds available and bank IRA certificates of deposit available at little or no annual cost.

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