This post is from staff writer Sierra Black. Sierra writes about frugality, sustainable living, and getting her kids to eat kale at Childwild.com.
When a friend of mine changed jobs recently, she discovered she had half a dozen old 401(k)s trailing her from her past jobs. She wanted to get on top of her financial planning, but wasn’t sure what to do with all those old investments. she asked me for advice.
Truth is, I wasn’t sure either. I cashed out my one 401(k) to buy a house several years ago. I know that was a dumb move in the larger financial story of my life. Saving early for retirement is one of the best ways to build wealth. I can’t undo it now, though, and I’ve been so focused on paying off debts I haven’t thought much about retirement planning for years.
As my debt burden shrinks, it’s time to start thinking about my own investment strategy. So I looked into my friend’s question: What should she do with those old 401Ks?
What To Do with Old 401(k)s
According to Schwab, there are four basic things you can do with a 401(k) when you leave a job. These are:
- Take the cash. You can cash out your 401(k) and pocket the money. This is basically Bad Plan Theater, though, unless you’re unemployed and otherwise destitute. Cashing out your 401(k) at any time before retirement is a permanent hit to your future wealth. You can regain the savings at a future job, of course, but you’ll never regain the time you lost earning interest on those savings. The dollars you put into your 401(k) when you’re 25 are worth much, much more to you than the dollars you put in when you’re 40. You want to let your investments age as long as possible before you need to withdraw that money. In addition, you pay 28% in taxes and a 10% early withdrawal penalty for taking your money out of your 401(k). The fees and taxes make this an even worse idea — no matter how tempting it is.
- Do nothing. If you do nothing with your 401K, it’ll just sit there accruing interest (or investment returns) on whatever money was in it when you stopped contributing. This keeps your money in the same investment plan it was already in, with the same terms and fees. This might be the best option for some people: if your new employer doesn’t have a retirement plan you like, or if you’re starting your own business and want to keep your 401(k) unchanged.
- Rollover your 401(k) to your new employer’s retirement plan. This is the best option for most people. You can do it without penalty, unlike when you cash out the 401(k). Rolling over your 401(k) keeps things simple. All your investments are in one place, where you can easily keep track of how they’re doing. In addition, all your new retirement contributions will be adding to the pot you’ve rolled over from your previous job. You’ll be limited to your new employer’s investment plans and options, though, so be sure to read the fine print carefully and make sure you like their offerings as much as what you have at your old place.
- Rollover your 401(k) into a personal IRA. This option gives you the most flexibility. You can put your investments anywhere you like, without being restricted to your employer’s plans. It might be the only choice for people becoming self-employed, other than leaving your 401(k) where it is. On the downside, moving your funds to an IRA may have less protection from creditors than a 401(k), and may carry an annual fee.
One more option: You may be able to roll your 401(k) over into a Roth IRA, as Jeff Rose explains at Good Financial Cents. A Roth IRA lets you deposit post-tax dollars and then withdraw money tax-free after retirement. In general, you’ll pay less tax on your retirement funds by funding a Roth IRA than a traditional IRA or 401(k). Making the switch to a Roth IRA from a 401(k) can be a little tricky, and the amount of funds you can do this with is limited. You may want to consult a financial professional if you’re planning to take this option.
Putting Theory into Practice
After looking at all the options, I advised my friend to consolidate her old 401(k)s into one 401(k) account with her new employer, and to keep contributing to her Roth IRA as well as her 401(k). She can put up to $5,000 a year into her Roth IRA, and her remaining retirement funds into her 401(k). That’s not expert advice — it’s just what makes sense to me after looking into the options. Depending on your individual situation and your employer’s 401(k) offerings, you may find a different approach works best for you.
When I start up my retirement savings again (hopefully this year!), I’ll be following a similar tactic: setting up a Roth IRA and investing in that account first. Anything above the annual deposit limits that we can save will go into my husband’s 401(k).
Since I’m just starting out at this, I’m even more interested than usual in your experiences. What have you done with old retirement accounts when you’ve changed jobs? What types of accounts do you rely on for your retirement savings?
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Awesome! I’m actually switching jobs right now and had a few ideas of what I could do with my 401(k). This article confirmed my suspicions!
Most likely, I will either move my 401(k) to my new employer, or roll it into the Roth IRA. Hopefully the transition is smooth….
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When I switch jobs I always roll it over to my own IRA. I do not like being stuck with the options of the employer plan. Also, you can roll other employer sponsored accounts, such as a SIMPLE IRA, into an IRA. I’m not sure you can roll a SIMPLE into am401k however.
Overall I just think rolling over to an IRA gives you the most flexibility and control. People are changing jobs so much more now than in the past. Having all of your old 401k accounts in the same place will make it much easier to keep track of.
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I have an old 401k from my first job. I was only eligible to put $200 into before I left the job. I left it at the old company and haven’t moved it since it’s such a small amount. However, I did look into my options with moving it. Rolling it into a Roth gives me more flexibility to invest it in anything I want – stocks, ETF, mutual funds,etc. If I put it into my company 401K I can only invest in the options they have available, which are about 15 mostly target date funds. Also, the 401k limits how often you can move the money around into different investment vehicles and have timeframes that you have to leave it in an investment or you pay a penalty. Some people prefer the security of target date where they put it in and forget about it, but I prefer having flexibility to do what I want, when I want to it.
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When both my husband and I have changed jobs in the past we have rolled over our 401(k) into IRA’s. As Rob said above, I have a lot more control over it that way. Actually, this year I rolled my Rollover IRA into a Roth because it was quite small and I could afford to pay the taxes on it. We left my husbands alone because it is large enough that the tax hit would be a problem for us.
Currently, we contribute up to the match in our 401(k)’s and then contribute what other retirement money we have to our Roth’s. As soon as we are able to get up to the max Roth contribution then we will contribute any more retirement savings to our 401(k)’s.
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This post also provides the answer as to why it is important to keep contributing to a 401(k) at your job, even if you do not plan to be around for a long period of time.
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Regarding rolling the old 401(k)into your new 401(k) as opposed to an IRA:
Most brokerage firms actually do not charge an annual fee for IRA accounts. (Though you’re right that a few do.)
In contrast, most 401(k) plans do charge an administrative fee. (See this Deloitte study for background.) In addition, you’ll sometimes be limited to high-cost funds.
In other words, if you’re seeking to minimize costs, rolling to an IRA is a better bet as long as you choose a low-cost brokerage firm (Vanguard, Fidelity, Schwab, etc).
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In my mind, there is really only one option here instead of 4:
Roll it over into an IRA, preferably at either Fidelity or Vanguard. You will gain a wider array of investment choices, have total control over the account, and likely get investments at a lower cost (lower expense ratios).
Don’t leave it.
Don’t cash it out.
Don’t roll it into a new plan.
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You can make a one-time contribution to seed an HSA, and in my family’s mid-range plans are a career change that would mean moving to my inusrance which is an HDHP/HSA, so I’m in the process of rolling an old 403b that’s been idling for 5 years to an IRA that’s been idling for 4, with plans to then fund our HSA with that. I have another 403b at my current job, so am still actively saving for retirement, and the HSA can theoretically be used for medical expenses at retirement, but with 30 years to go and two kids under 5, I’m just going to assume we’ll be using it for medical expenses before then.
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This is very timely for me. I am leaving my current job to go back to school in a few months and I was wondering what my options were for my TSP account. Thanks!
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A correction on the taxes for cashing out – you will be taxed at your regular tax bracket if you take the money and run (not everyone is in a 28% tax bracket) as well as any state tax, *and* the 10% early withdrawal penelty if you are under 59 and 1/2.
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I just wanted to add that if you are going to roll it over into your new 401K, make sure that you like the investment choices in your new 401K just as much or better than your old one. I have kept old 401K’s open because they had better investment options, though last year my current employer hired a new 401k administrator and the choices got drastically better, so I finally rolled everything over to a company plan.
I did want to add a funny story though – one of my first jobs, I held for a year and had about $4000 into my 401k. I ended up quitting and moving across the country. about 7 month later, I got a check. Turns out that the employer didn’t have to keep the account open, and decided that the administrative expenses were a hassle, and without consulting me they just decided to cash it out and add to my tax burden! Since then, the laws have changed – employers can still do this, but only if the balance is under $1000. I ended up working back for them later and accumulated about $1100 in my 401K. When I left the second time, I kept it open for YEARS just to make them pay the administrative costs of keeping it open, mailing me statements, etc.
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I have a 401k from a previous employer and an IRA I hadn’t touched in years from one summer when I had a huge (at the time) influx from a summer job in college. For the time being I’m keeping these where they are, as well as contributing to my current employer’s 401k. I plan on adding money to my IRA as well, although that company’s earnings have made me less excited to transfer that deposit.
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I think it is a bit more complicated. Old plans may offer institutional funds (often less expensive than what is available to an individual investor in an IRA) and the costs may be lower overall in an institutional 401k.
Rolling a 401k into a Roth IRA can be a great idea but there are tax implications for many people that may make it an expensive option depending on the size of one’s 401k.
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I’ve rolled three or four 401k’s into a rollover IRA I have with TD Ameritrade. I don’t pay any annual fees with them. Actually, I have 3 types of IRA’s (Roth, Traditional, and Rollover) and a taxable account with them. I only keep my current job’s 401k.
It makes it much easier to keep track. I love their feature where you can see what you’re invested in across all of your accounts.
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Cashing out is tough, but sometimes necessary. I had a small one with a former employer and I had to look at the interest on credit card debt vs the penalties, and how this set me up for a recent home purchase. While it is inadvisable, I will put a vote in “do not have any regrets about it” AS LONG AS YOU UNDERSTAND THE TAX & PENALTIES. I was able to set aside a chunk of it after cashing in to anticipate the liability, which meant I was actually able to have a “wash” when I did my income taxes. Yes, it is smarter to not cash it, but cashing it to lower liabilities is not “dumb”. Cashing it to buy a big screen TV or car is… “not as smart…”
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I just noticed this:
“Making the switch to a Roth IRA from a 401(k) can be a little tricky, and the amount of funds you can do this with is limited.”
That’s not exactly correct. There is no limit. (Though, practically speaking, if your 401(k) is very large, the amount of tax due may make such a procedure prohibitively expensive.)
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mine was a roth 401k, so I couldn’t roll it into my new employer’s plan, and the rates of return were pretty crappy, so I am in the process of trying to roll it into a roth ira with my credit union instead. But oh man, it’s a pain, mostly because the company who has the 401k now is twiddling their thumbs a lot. I think they’re trying to just delay the process so much that eventually I’ll give up and just keep the money there, honestly. I try not to be a cynic, but seriously, they’ve just sat on my paperwork for forever.
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I’m an afficianado of low-cost index investing. I advocate moving the funds to Vanguard or another, similar organization.
In my experience a lot of employers offer really lousy options for retirement funds, with high fees even in index funds. Many of the Vanguard funds let you invest as little as $10,000 in their Admiral funds which charge as little as 0.5% in annual fees. For even those with smaller 401k balances, you can allocate risk across your entire portfolio by putting your old money in one or two Vanguard admiral funds (say large cap and mid cap), and set your new retirement fund to go into small cap, international and bond funds.
I’m just getting ready to do this myself, as my employer recently changed plan administrators and I have the opportunity to move my funds to any place I want. I’m thrilled that I’ll be saving more than 1% per year on most funds.
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There was a discussion of old 401(k)’s at my networking meeting yesterday. The financial advisor who spoke recommended rolling over into an IRA. The reason for this was because of inheritance issues.
If you make an adult child the direct beneficiary of your 401(k) and you die before they reach retirement age themselves, the can’t keep the 401(k) and have to cash it out, which, as Sierra pointed out in the post, is expensive.
But someone can inherit an IRA and just let it sit and grow until the are old enough for disbursements.
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I agree with poster #8. Why trust your new employer with this money? Chances are slim that you’d stay with that employer to retirement.
You would be hard-pressed to have an employer that will give you the range of investment options and lower annual fees than putting into your own IRA with low-cost index funds. Over time that one decision has a big impact to how your money grows over a number of years. Also, I find the self-managed IRAs have more accessible information, tools and graphs that help you see how your money has grown. These are simple graphs, but they help motivate me to save even more.
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The advantage of rolling it into your own IRA instead of your current employers 401k is control. You can control what you want it in. With your current employers 401k it’ll likely be in mutual funds with fees and some of those fees can be steep – 1% may not seem like it is, but over time it’ll take a chunk of your retirement. The easiest thing is to roll it into a Vanguard (or similar) IRA and just do index funds – they are very, very cheap and if properly selected can give you greater diversification. If you enjoy actively trading stocks you probably already know the advantages of active trading within an IRA… no taxes on your gains (but deductions on your losses either so trade wisely).
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Another point that hasn’t been made is that if you have multiple accounts it is in your best interest to combine them in one account. First of all, it makes it easier to track the money as it reduces the amount of mail you receive. Secondly and possibly most importantly, you may be able to get really good deals. For example, if you have four old 401 accounts, each for $7,000, by combining the accounts into one account, you would have a total of $28,000. It’s quite possible that there is an IRA out there that will offer you reduced costs or points to manage accounts that are over $25,000. In other words, it’s cheaper to you if the money is being managed as one account.
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Andy (18) has a great point.
Just to provide an example: If you move everything to an IRA at Vanguard, many of their funds have “Admiral shares” that are available if you have $10,000 or more in the fund. Admiral shares’ expense ratios are approximately half that of their normal funds.
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As far as tax implications on Roth’s we discovered during filing taxes this year that the Roth conversion we did in 2010 can be dealt with 2 ways. Either take the tax hit this year or divide up the income (Roth amount) over 2011 and 2012 to split up the tax hit. We chose the second option so we can plan ahead and have the right amount of tax withheld. It can be a big hit but it isn’t bad if you plan for it. Better to take the tax hit now before it grows to retirement levels!
I hope that those that are funding Roth’s first are at least doing their employer match amount in their 401k’s. It is free money!
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I am on job #3 with company #5 (acquisitions) now, and I would never leave my retirement money with the old company. I’m OK giving them control over my choices when I’m working there, but not afterward.
I have so far rolled over my 401(k) monies into an regular rollover IRA at one of the major discount brokerages. We also have DH’s rollover IRAs there, as well as contributory and Roth IRAs. As someone has earlier commented, it’s nice to have everything in one place. I’d hate to have a previous employer “lose” my savings or lose track of me after a move.
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I had a Roth 401K at my old job – my contributions were post-tax (Roth) but my employer’s contributions were not. After a large percentage of the employer’s funds were removed due to me not being fully vested (there was a lesson for me!) I rolled the rest of the funds into a self-directed Roth IRA (the non-Roth portion had to first go into a regular IRA, then get transferred to a Roth and taxes were paid). Since then, I’ve used the self-directed Roth IRA to invest in corporate debt and real estate.
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Another loud voice for rolling it over into an IRA (except in the rare case that your old or new employer has awesome funds with really low fees). You’re likely to have much cheaper options that way, and you don’t have to worry about what’s going on with your old employer. And you’ll definitely have more choices, which is handy if your employers don’t have what you most want.
Once you roll it into your new employer’s fund, it’s stuck there as long as you work there.
I rolled my last one into an IRA and then again into a Roth IRA since it was small enough that I could afford to pay the taxes. Since I think taxes can go nowhere but up, that makes me happy, too.
(I also have the impression that you can roll parts of IRAs into Roth IRAs so you don’t have to pay all the taxes at once, but I’m not sure that’s true.)
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With the federal government’s option, the TSP, you’d be hard pressed to do better on your own terms. The expense ratios & fees are lower than Vanguard or anyone else. Also, they offer pretty good index options (you’re out of luck if you want active funds).
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I second #8′s response. Roll it over it Fidelity or Vanguard IRA. Low expenses, plenty of options, great track records.
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I am a recently retired federal employee. I have a 403B(Thrift Saving Plan) that many companies want me to move. Since I do not plan on adding to it, I looked at the expense ratio. Since the TSP expenses were much lower and the stocks are indexed like Vanguard or Fidelity, lower cost means more money for me!
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Be careful with option 2 (Do Nothing). Some employers charge fees to ex-employees who don’t rollover their 401ks to another account. These fees are on top of the regular account fees charged to current employees.
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@ 22(Debbie M); You can definitely roll over part of a regular IRA to a Roth IRA. Every year I figure out how much money would get me and my husband to the top of the 15% tax bracket and roll over that much into my Roth with a simple phone call, since both IRAs are at the same company. We have enough cash to pay the extra taxes, and this way we hope to minimize taxes paid down the road.
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It may have been mentioned, but there is one piece of advice I’d add to the post. I’d contribute to your 401k FIRST up to the employer match THEN max your IRA then come back to the 401k. With limited funds, take the free money first!
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Sierra – You mentioned YOUR strategy, of funding a Roth IRA, then putting any additional into your husband’s 401(k) plan. I hope you and your husband are already funding his 401(k) so that you take maximum advantage of any company match! That’s pretty much “free money” — don’t leave that on the table!
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I have rolled all of my old 401k/403b’s into an IRA at TradeKing. If I leave this job, I’ll do it again and just keep growing that account. I don’t like the idea of keeping old 401ks with old employers because they usually have limited choices of investments in their plans. Once you roll it over you can choose just about anything you want.
Psychology I love to have a small set of accounts. It makes the investments easy to track and I don’t have to worry about changes my prior employers may implement.
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I’m rolling an old 403b into an old IRA, but my family’s plans in the mid-range will involve moving to my current company’s insurance, which is a HDHP with HSA, and I plan on seeding the HSA with the IRA. It’s still ‘my money,’ even if I leave, but it makes going to the HDHP/HSA plan much more feasible (and we don’t have the cash to seed it outright. If that doesn’t come to pass, I’ll just keep the IRA as a repository for those wayward accounts. (And we both contribute to our existing retirement plans at our current companies.)
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I rolled mine over into my current employer’s 401k, since it is with Fidelity. The fund options are very reasonable (including, for example, an S&P 500 index fund with an expense ratio of 0.02%…)
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I would roll over into an IRA at a discount broker. This would give you unlimited choices on your investments. You can buy low cost ETF, individual stocks and many other products.
Don’t roll it over to a new employer’s 401k. Most 401k plans are very restricted in their investment choices.
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@ Meg #9:
Check your options before moving money from the TSP account. I read that those funds are some of the best managed and wish I left my money there after leaving work with the feds.
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@Meg (#9)
The Thrift Savings Plan is considered to be the best defined contribution plan (i.e. 401k) available. This is because the funds in it are much cheaper than funds offered anywhere else. You should seriously consider leaving your money in your TSP even after you leave that employer.
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Could someone with one of these 401ks with crappy investment options list the options they’re actually given? Mine has always seemed pretty reasonable.
My 401k is invested in:
Spartan 500 Index – Investor Class (FUSEX)
Oppenheimer Developing Markets Fund Class Y (ODVYX)
Spartan International Index Fund – Investor Class (FSIIX)
There are about 30 available investments, including the domestic and international index funds above. Do I just have a really good 401k, or am I naively missing out on something else? Ours is through Fidelity, so I’d figure a lot of other people would have similar plans, I’m sure there are lots of Fidelity 401ks out there.
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I just rolled over my last 401k plan into my ROTH IRA, in order to take advantage of the two year averaging for 2011 and 2012. (Sorry, you had to make this transaction by the end of 2010). One reason was to take control as others have said, an(annual fee is now a smaller percentage of the total) other was to boost the size of my ROTH account and lastly, now I can invest it how I wish.
Plus this way you can ensure that your account beneficiaries are up to date. What if your old 401k beneficiary was your former spouse-and you no longer wish them to inherit upon your death?
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You can also roll funds from a regular IRA to a Health Savings Account. I recently uncluttered my retirement accounts (had a big old 401k sitting around, a smaller rollover IRA from a previous 401k, a little bitty Roth IRA, a new 401k at my new job, and the HSA).
I rolled the old 401k and the rollover IRA into the new 401k, and the Roth IRA into the HSA. From five accounts to two. There was a maximum I was allowed to move from the Roth IRA to the HSA, but the amount left over in the Roth IRA was less than the amount I had contributed, so I was able to cash that out without penalty. And used it to pay off a credit card.
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This is not very good advice, nor does the author explore the factors that someone should consider when making the decision. 401Ks generally have much higher (and very opaque) fees with less investment options. My 401K has no ETFs, just mutual funds. Why limit yourself? Also, the author didn’t touch upon other factors to consider, such as the legal protections available for each type of investment. In some states IRAs are up for grabs in the event of a personal liability suit but 401Ks are not (they are protected by ERISA), but it varies. If you are close to retirement there’s also the withdrawal rules/min. distribution to consider, as they differ. And I believe it is easier to borrow from an IRA versus a 401K; there are different rules for each, so another factor to consider that the author did not.
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Is an IRA as judgment proof and bankruptcy proof as a 401k? I don’t think IRAs are covered by ERISA. If not I’d leave it in a 401k – either with the old employer or roll it over to the new employer’s 401k.
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Hey guys–this is staff writer April. I’ve just fished out a dozen comments from the spam folder, so be patient with me if your comment didn’t show when you posted it.
J.D. is probably a lot faster at sorting through the slew of spam!
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WARNING ABOUT ROTH IRA ROLLOVERS
Sierra mentioned a warning, but I don’t think it was strong enough! See a tax professional BEFORE rolling to a Roth IRA. You pay tax on the whole amount at your tax rate. This money generally can’t come out of the amount you roll. *unless you take out some of it and pay the tax and penalty on that*
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Two other things to consider:
You can borrow from a 401(k) but not an IRA;
401(k)s are protected from bankruptcy but IRAs may not be (state law applies to IRAs)
Generic advice: roll to new 401(k) if you are happy with the choices and fees.
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Is it true that when you retire and pull the money from your IRA that you will be taxed on it. Wouldn’t it be better to pull your money now and invest it in insurance contracts? With insurance contracts, you can take a loan out on it and it will not be taxed because it is a loan and therefore not taxable income.
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