When You’re Forced to Turn Your 401k…into an IRA.
Should you or someone you know, be faced with separation from your “soon-to-be-ex” employer, the above title likely resonates with you. Amidst the confluence of task surrounding an employment transition is of course – “should I maintain the old 401k, or roll it to an IRA”.
By the way, should you currently be facing this, you’re not alone.
There’s an old saying “A recession is when your neighbor lost his job, a depression is when you lost yours”. A quick survey of the local landscape suggests an increasing presence of both. Whether it be State Street (558 jobs in MA) John Hancock (3% of local workforce) in Boston, Hasbro (145 jobs) in East Longmeadow, Baystate Health (354 jobs) in Springfield, or Sabic’s closure of its Headquarters of Americas (300 jobs) in Pittsfield…it’s being felt statewide.
So what to do?
From someone who’s been on both sides of the fence for almost 30 years – having designed and implemented company sponsored plans, as well as assisting employee transition from them – here are 4 key items to consider.
As you likely know, once we all turn 70½, the IRS wants their share. As such, you must begin mandatory withdrawals from a traditional IRA, even if you don’t retire. Not so with the old 401(k) – it’s not subject to this rule as long as you continue to work. So if you plan to continue punching the clock well beyond your 70th birthday, a 401(k) is advantageous in reducing your taxable income.
Upon departure from an employer, many feel a sense of disconnect and even betrayal in the case of layoffs. As such, some feel a sense of unease about leaving their accumulated assets within a plan they are no longer an active participant in. In the case of layoffs due to downsizing, there may actually be some legitimacy to those concerns. Having provided assistance during downsizing to companies such as AT&T, Wang, Digital, and Polaroid, I can attest first hand to the restricted access imposed on former employees.
While we can stand on principal and talk about why it’s not prudent to prematurely access your retirement assets, if you’re considering it, you’ve likely belabored the decision. That said, whether your thoughts are for now, or potential access down the road…some things to consider;
- Withdrawals from your company sponsored plan.
Early withdrawals (those taken before age 59 1/2) from a 401(k) are taxed at your ordinary income tax rates, plus a 10% penalty imposed by our friends at the IRS. There are exceptions however. Those include disability, a layoff after age 55, a qualified domestic relations order (QDRO), or death.
- Withdrawals from an IRA.
Early withdrawals from an IRA are also subject to ordinary income taxes, along with the same 10% IRS penalty. However, there are exceptions here as well. You may withdraw funds without incurring the 10% penalty if used for qualified education expense, disability, medical expenses above 7.5% of your gross income, up to $10,000 for a qualified first home purchase, or as “Substantially Equal Periodic Payments” (SEPP) under rule 72(t).
4. DO THE INVESTMENTS STILL MAKE SENSE?
A question I hear a lot. The answer is, likely not…and here’s why.
While the majority of plan providers have been extensively vetted, and are usually extremely competent custodians while accumulating assets during employment….for ACCUMULATED assets, it can be a very different story.
For the most part, 401k investment options are composed of what’s known as “RELATIVE RETURN” portfolios. Simply meaning they’re designed to achieve favorable performance “RELATIVE TO” the market. Therefore, upon examination you’ll find they simply “track the market”. So if the market’s up or down, you are as well. While this works well for those dollar cost averaging with several decades of work ahead…not so for those with accumulated assets.
Why is that?
Consider having retired in 2000 with a nice nest egg. Had you, like so many others, retained a relative return portfolio that tracked the market, aside from a few months in 2007, you would have been underwater for most of the last decade and a half. Assuming withdrawals, you’d likely still be underwater.
- Plan Sponsored Target Date Funds.
In response to the above, the industry came up with Target Date Funds as a solution…or so they thought. In fact, they were so convinced of their effectiveness, they became the default allocation at enrollment. So if you planned to retire 20 years from now (2035), they’d enroll you in the “target 2035 fund”. Simple enough. As such, upon retirement or departure from the company, many felt obligated to maintain these accounts as a sort of “set it and forget it” retirement option.
The thought was…by leaving it as is, the guess work is removed from retirement savings by automatically having your asset mix adjusted by the fund from predominantly stocks to predominantly bonds as you age. By doing so, the hope was to reduce potential losses in your portfolio at the very point you need the money the most. The problem…the fund architects assumed more bonds equals less risk…not so.
In fact, in 2009 “Forbes” reported “…investors holding 2010 funds suffered losses of 40% last year.” Meaning, just 2 years from the “target”, there was virtually no risk mitigation. So much for a solution.
As a result, many I’ve worked with have opted to roll their assets to an “Absolute Return” IRA portfolio that positions you defensively in bad times, yet opportunistic in good. A little something institutional investors (pension funds, foundations, endowments) and high net worth investors have been quietly keeping to themselves for decades. Might be worth consideration.
So the question still remains….what to do?
Should you have accumulated assets, wish to maintain consistent access control, and are concerned about market volatility effecting your portfolio – as you should be (see my last post “Sometime cash is your best option…like now”) – possibly being forced to turn your “Relative Return” 401k into an “Absolute Return” IRA is a blessing after all.
WATCH THIS SHORT VIDEO – Featuring Mark Kinney discussing “Absolute Return” portfolios in an easy to understand format.
ABOUT THE AUTHOR:
Mark Kinney, Certified Financial Planner ® (CFP) Practitioner has been cited nationally on CNN, Fox Business, NBC, ABC, CBS News, and more…
As the founder of Toole Kinney & Company, his focus is as it’s been since 1987 – maximizing client retirement income in a sustainable, repeatable, and verifiable manner, while minimizing risk exposure to the daily turbulent financial markets through the use of highly disciplined quantitative strategies.
Mark can be reached at firstname.lastname@example.org