With the implosion of the housing market, a defined contribution (DC) plan such as a 401(k) or 403(b), can represent a person’s single largest asset. With regular contributions a person in their forties or fifties could easily have account balances in the hundreds of thousands of dollars. Even younger workers who have regularly contributed to their employer’s plans can have significant account values.
With potentially so much at stake, I often get the question as to what to do with these accounts when you leave a job, either voluntarily or not. In the case of those of you that have held jobs at various companies, you may have left your money in a previous employers plan and own multiple DC plans at multiple companies. If you had more than $5,000 in your account most plans will give you an option as to what to do with your account. In most cases you will have four options:
• Keep the account in the employer plan where it was started
• Roll balance into the plan at your new employer (if there is one and they accept the transfer)
• Rollover the balance into an Individual Retirement Account (IRA)
• Cash out and take the money
There are many articles that have been written on the pros and cons of the various choices and most do a good job of assessing the options from a 50,000 foot level. I have summarized these in the chart below.
First, as a rule, unless it is absolutely a last resort, cashing out is not a good idea. Not only are you subject to tax and penalty but you are losing the long term growth in the value of those assets which could severely hurt your retirement plans.
Here are the Pros & Cons:
Leave your money in the employer’s plan
-May be able to take loans against balance
-Can take penalty free withdrawals for certain needs such as education and a first house -Investment choices are restricted
-Lack of flexibility
-Can take penalty free withdrawals but depletes retirement assets
Roll the funds into your new employer’s plan
-No real additional benefit over leaving the assets at the previous employer
-Investment choices are restricted
-Lack of flexibility
Roll the funds into an IRA
-Maximum flexibility to allocate your assets
-Allows access to asset classes not available in DC plans
-Allows you to work with the financial professional of your choosing
-May lose benefits unique to a specific DC plan
Cash out and take the money
-Access to a potentially large sum of money
-You will have to pay income tax
-If you are younger than 59 ½ you will pay an additional 10% penalty
-May put your retirement plans in jeopardy
The problem, in my opinion, is that there are a bigger issues concerning managing your retirement accounts that do not seem to get the attention they should. Most of what is outlined in these articles and summarized above assumes that, with the exception of taking the money in a distribution, you are still making all the investment decisions. Here may lie the biggest of all issues which, in my opinion, is that most people have no long-term financial plan in place for managing their assets.
Who’s in charge? – Who’s looking out for my money?
One of the most concerning issues related to DC plans is a general lack of understanding on how the investments are managed. Many people I speak to are under the impression that the company is involved in the management of the investments in much the same way as they are in a pension plan. This could not be further from the truth. In a pension plan there is a pension committee which often times contains members of the executive committee and Board of Directors. The committee will draft an investment policy for the plan that will determine the asset mix and when and how managers will be hired and fired. The individual participant in the pension (you, if you’re lucky enough) has no responsibility or ability to choose investments or make decisions. You, as the beneficiary of the pension, are getting a benefit that is defined by the plan documents (a defined benefit). How the company gets you that benefit is pretty much their concern.
A DC plan on the other hand, is a benefit that is usually managed by the benefit group in the Human Resources Department; kind of like your health insurance plan is managed. The company will decide who the administrator of the plan will be and the level of service that will be provided. Based on the service level the plan provider will offer the participants a choice of investments. In some cases it will be a lineup of mutual funds and in other plans it may be a select number of portfolios based on risk tolerance or anticipated retirement date. The responsibility for choosing which investments to invest in, the asset allocation, and all other investment related decisions are up to the participant. THAT MEANS YOU! The company has no control over what goes on with the management of the individual investment choices. Unlike a pension where an under-performing manager will be fired, it is up to you to move your money out of an under-performing fund.
So what’s your Plan?
Saving for retirement is probably the most important long-term financial decision making process you will undertake in your life. With the uncertainty surrounding Social Security and the traditional pension going the way of the dodo bird, the responsibility for funding our retirement falls increasingly on our shoulders. So what’s your plan? Are you like most that don’t have a plan?
In a 2009 study published by WebCPA, a survey of 1,742 consumers found that only 36 percent had a written financial plan and of those only 17 percent indicated that they regularly reviewed and updated the plan. In addition research by Wharton School of Business professor Olivia Mitchell showed that people are not well equipped to handle financial decisions and that among the “boomers” studied, only 24 percent “gave much thought” to retirement. This problem was best illustrated in that those that had planned for retirement “hardly at all” had a median net worth (2008) of $80,000 while those that had put a financial plan in place had a median net worth of $202,000. According to Mitchell “as to the question of whether planning causes wealth or visa-versa; the study found it was a one-way relation: planning causes wealth”
How are you making your decisions?
The problem is that many DC plan participants never talk to a financial professional. While many companies give the employees the opportunities to talk to an advisor associated with the plan, most seldom or never do. In most plans you are sent an enrollment package when you are entitled to join the plan and from there you pick your deduction amount and investments. Sound familiar? How many employees in a company are really qualified to make this decision? Many simply rely on the advice of family, friends, or coworkers who simply quote the “conventional wisdom”. Is it fair to ask an employee to read a prospectus and perhaps scour a website (or worse yet the financial gurus) for information in order to make one of the most important long-term financial decisions they will ever make? This only gets worse when the employee must make investment decisions during times of “market unrest”. What did you do in 2008?
So how do you decide what to do?
My goal in this article was to point out that even the decisions that seem the simplest on the surface, may actually be more difficult and complex than we imagined. The world of finance is much more complex than it was 20 years ago. Bad decisions can have long lasting impacts. The way to minimize these issues as well as helping you to sleep at night is to work with a financial professional and create a plan that you can follow. Wouldn’t it be easier to navigate the complexities of the financial world having a roadmap?
Before you decide on leaving the account at your previous employer, taking it with you to the new job, or rolling it over, can you answer these questions:
• Do you have a written financial plan?
• Do you have a goal in mind?
• How good are the investment choices in the old/new employer plan?
• How well do you understand the choices and the risk associated with each?
• How well do you understand the risk in your account as a whole?
• What are the fees and expenses associated with the plans or an IRA?
• How confident are you in your knowledge and ability to make the necessary investment decisions now and in the future?
Like every other decision in finance, what to do with your DC plan when you leave a company, is one that must be fully analyzed. Contrary to some popular opinion, there is never a “one size fits all” solution. No one answer will be right all the time for everybody. Each one of us has his or her unique situation. You should have the right to have all the information and knowledge required to make such important long-term decisions. Your first and most important decision should be how you will get that knowledge. If you choose to use a financial professional, they will help you analyze the options based on the financial plan that you have created together. However, if you plan on going it alone, than the decision as to what to do with the account should be decided by doing an analysis of each plan and your choice of IRA investments to see which offers the most benefit for the price being paid and the risk you are willing to take.
David J. Seibel is founder and Managing Partner of AGS Aurora Financial Services LLC, an independent financial advisory firm in Matawan, New Jersey