Why Leaving Your 401(k) At Your Company Might Be a Big Mistake!
This is a very important issue because many people, unfortunately, leave their money in their 401(k) plan or other qualified retirement plan at work even after they retire! This is usually the wrong thing to do! Let me explain. The following example is for illustrative purposes only.
Let us assume that we have Bill and Mary , who are happily married and have two children, Bob and Susie . Let us assume that Bill has worked at Large Energy Trading Company (LETC) for 40 years and has $1 million in his 401(k) plan at work. Mary is the primary beneficiary and the children are the two contingent beneficiaries. Obviously, while Bill is still working, this is an excellent plan, since he is able to take part of his salary and contribute this to his 401(k) plan while, in most cases, the company is also usually going to match part of this contribution.
This is a great way to save and most of you are very familiar with the scenario.
Now let's change the facts a bit.
Bill now retires. He is thinking about keeping his money in the 401(k) plan. He's familiar with the investments and he also believes that the plan has reduced expenses and he would not have to pay anyone else to manage these investments.
Unfortunately, Bill is probably not aware of the many options that he has available to him. For example, if he rolled over the money into an IRA, he would have unlimited investment alternatives available to him. The average 401(k) plan usually has less than 10 investment options.
In addition to this, although he feels that there would be reduced fees if he remained with the plan, Bill has probably never compared the actual rates of return after expenses of the investments in the plan versus the alternatives outside of the plan. There is a very good likelihood that the return on alternative investments could be more competitive. Investors should be aware that risks are inherent in all investments.
However, that is not the most important reason why leaving your money in a 401(k) plan is usually a very large mistake! Let us walk through the following example, which is for illustrative purposes only.
Let us assume that Mary is the beneficiary. If Bill should pass away, Mary would have the right to take the distribution from the 401(k) plan and roll over the money into her own IRA, in which she would most likely name the children as the primary beneficiaries.
However, there is obviously a possibility of Mary passing away first. If she passed away first, then Bill would most likely change the primary beneficiary from Mary over to his two children. This is where the major problem lies.
If Bill should pass away at this time, with a non-spouse beneficiary such as his children, the 401(k) plan would usually require the account balance to be paid out within a short period of time, often only in one year! Although the IRS allows you to elect to take out the distribution over the children's lifetime for 401(k) plans at work, very few 401(k) plans even allow this. In such cases, the 401(k) plan terms trump what is allowed by the IRS.
I know that many of you might be thinking, “Well, let me just continue the 401(k) as it is after I retire and if my spouse passes away first, then I will roll it over. In the meantime I will just keep it the way it is.” Unfortunately, this has its problems too. An example would be simultaneous death, such as a car accident. Since it is almost impossible to determine who passed away first, the 401(k) plan will often still require the account to be paid out in only one year! Just think of your entire retirement account being distributed and taxable all in one year!
Therefore, the bottom line is that in most cases it is best to roll over your money from your 401(k) plan into an IRA immediately after your retire.
This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. We suggest that you discuss your specific issues with a qualified tax advisor. © MDP, Inc.
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