“Mr. Jones, we appreciate your work for us, but unfortunately there’s just not enough room in our budget for you.

Here’s a packet of information regarding your retirement account.  Please look this over and have a decision made about your 401k plan by the 31st.”

Ever hear these words?

Maybe your company didn’t sound as nice, but the result was the same.

Or – perhaps you left on your own terms and are embarking on a retirement journey or looking for a new career path.

Any way you slice it, there is one question that remains:

“What should you do with your 401k plan?”

Let’s take a look at four options to help you make an informed decision on what you should do with your 401k plan upon retirement or separation from service whether you have a million dollars or several thousand.

Leave Your 401k Plan With the Current Company

Generally, you can leave your 401k with your current company – or should I say your previous employer.

But this isn’t always the case.  Many times, companies want you to get those funds out of there because of costs to them.

If your company does allow you to leave it – then you can just keep your 401k plan with the same custodian, use the same investments and keep things as is.

Advantage:

It’s easy, generally cost effective and doesn’t require much thinking on your part.  Just keep the status quo.

Disadvantage:

You have your money with your former employer’s custodian.  That could possibly make for some discomfort – even though your employer legally can’t do anything with your money, some folks would rather cut ties completely.

Your money is invested with whatever custodian your company chooses – and they can change whenever they want, to whomever they want.  That means your funds could change simply because your former company wants to change.

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Take a Distribution From Your 401k Plan

You could take money out of your plan, have a check cut and sent directly to you.  Perhaps you need the cash and are more worried about making ends meet with the loss of your job than you are about preserving your retirement future.

Advantage

Access to cash if you need it within a relatively short period of time.

Disadvantage

If you are under age 55 when you retire or separate from service there is a 10% penalty for early distribution.  

If you are over 55 that is waived.  Yes, you read that right – age 55. This is called the age 55 Exception where the IRS allows you to take a distribution from a 401k provided that you are age 55 at the time of your separation from service and that you leave your 401k at your company – in other words you cannot roll it to an IRA first and then take distributions and expect to avoid the penalty.

There is also a mandatory 20% tax withholding from your custodian, which they will send to the IRS for you.

Take Your 401k Plan With You to Your Next Employer

One option you may have is to take your 401k plan with you to your next job.  You’ll have to check with your new employer to find out if this is allowable, but generally speaking many plans will let you transfer that old 401k into the new plan.

Advantage

Easy.  Combining your funds helps with compounding interest earned on that 401k balance.  There are no tax consequences.

Disadvantage

The new company may not have the greatest 401k plan available.  There may not be a good variety of funds.  Again, the custodian can be changed at the employer’s discretion, which means you still don’t have much control over your funds.

Roll Your 401k Plan Over to an IRA

You can do a direct rollover to an Individual Retirement Arrangement or IRA.

Advantage

You are in the driver’s seat.  The money is in your own account which you have discretion.  You can make changes, you can make the investment choices, you can pick the custodian or brokerage company that you feel most comfortable.

You don’t have the company limiting your investment options.  You can invest into pretty much anything you want.

You can even open a Roth IRA and do a Roth IRA Conversion on the money if you wanted to – you are making decisions, not your employer any more.

There are no tax consequences to performing a direct rollover.

Disadvantage

This requires a bit more work on your part.  For example, you’ll need to research a custodian, research investments – whether it is stocks, mutual funds or ETF’s.   You’ll need to essentially manage your own account unless you hire a professional to help you, which of course you’ll have to pay fees to do so.

The 401k generally allows for creditor protection in a bankruptcy or by plaintiffs in a civil lawsuit. IRA funds, however, are limited in their protection and the rules differ from state to state.

What Are Your Thoughts?

As you can see, there are some decisions to make once you leave your job. Some of these are more advantageous than others, so be sure you do your homework and figure out what’s best for you for your retirement.

Readers, what would you do – or what have you done in this situation?

Retirement is a fascinating topic don’t you think? 

Millions of people long for it, plan for it and obsess over it.

On a daily basis, people ask themselves questions like these:  when can I retire?; how much money do I need to retire?; and which retirement account should I be saving into as I get ready for that big day?.

The last question is what we want to tackle today – which retirement account is right for you?

We certainly won’t cover every single type of retirement account out there today, but I do want to tackle the big four – 401ks, Traditional IRAs, Non-Deductible IRAs & Roth IRAs to see which one(s) make sense for you.

Let’s take a look:

401k Retirement Account

401k legislation was written in 1978 and finally passed in 1980.  401k’s allow employees to choose to receive deferred compensation rather than direct compensation.  That compensation gets put into a 401k account that is invested.

401ks are tax-deferred retirement savings accounts.  Basically they allow you to reduce your taxable income, which gives you a tax-break now.

They also grow tax-deferred – meaning you are not taxed on the growth of the investments each year.

When you pull the money out in retirement, however, you must pay the Piper!  Uncle Sam will ask for all that deferral to be taxed.

Every dollar you pull out will be included in your taxable income for the year – it’s as if you earned that money. 

401ks – The Right Retirement Account for You?

401k retirement accounts are right for folks who like having an easy way to save for retirement (deductions are taken from your payroll), who want to reduce their taxes now and who are getting an employer match on their 401k contributions.

Traditional Individual Retirement Account (IRA)

A Traditional IRA works much the same way as a 401k except for the payroll deduction.  The limits are much lower in terms of what you can contribute as well.

If you are covered by a retirement plan at work and making between $56,000 and $66,000 for singles and $89,000 and $109,000 for joint-filers then the deductibility of your contributions are phased out.

That means you cannot deduct the entire amount of your contributions from your income. 

If you are making under that amount or you are not covered by an employer retirement plan at all, then you are able to fully deduct your IRA contributions.

Traditional IRAs – The Right Retirement Account for You?

A Traditional IRA is a great retirement account for those who may not have a 401k or other employer plan, or who perhaps do have one, but are making less than the phase-out limits and want to get tax advantages now.

Roth Individual Retirement Account (IRA)

Roth IRAs are Individual Retirement Accounts that do not give you a tax break up front.  Rather, they allow you to put in after-tax money, which then grows tax-deferred.

When you reach 59 1/2, you can take out your contributions and your earnings completely tax-free!

Like the Traditional IRA, the IRS has phase out rules for Roth IRAs.  For single filers, your Roth IRA contributions are phased out when your Modified Adjusted Gross Income (MAGI) is between $105,000 and $120,000.  Above $120,000 you are ineligible for a Roth IRA contribution.

For married filers, the phase-out limits are between $167,000 and $176,000 and above that you are ineligible for contributions.

Roth IRAs – The Right Retirement Account for You?

Who should open a Roth IRA?  Basically anyone who falls under the phase-out limits, wants to diversify themselves from a tax-standpoint and has ran the numbers and feels that income or tax rates will be higher in the future and their potential for tax savings is greater down the road than it is now.

Non-Deductible Individual Retirement Account (IRA)

A Non-Deductible IRA is simply an IRA that you contribute to when you are phased out of your deductiblility.  Remember how we said that if you are covered by an employer plan and make too much money you can’t deduct your contributions? 

A Non-Deductible IRA is the result.

Last year I would never have given the non-deductible IRA a second thought.  It made very little sense to contribute to them. 

This year, however, it may make a lot of sense for folks.  Here’s why:

The income limits for Roth IRA conversions have been lifted, meaning anyone can convert money to a Roth IRA!

I won’t get into the details of this strategy here, since I talked about covnerting non-deductible IRA contributions at length in this post - but quickly, here is the strategy:

Make Non-Deductible IRA contributions (no tax write off); convert those contributions to a Roth IRA (no taxes owed); let your money grow tax-free in the Roth IRA (no taxes owed) and then pull out the money in retirement (no taxes due!)

Non-Deductible IRAs – The Right Retirement Account for You?

This strategy is right for those who make too much money to simply contribute to Roth IRAs, but still want to take advantage of tax diversification by getting money into a Roth.

Which Retirement Account is Right For You?

Readers, let’s hear from you – which is your favorite retirement account and why?

According to Wikipedia, Baby Boomers are those who are born between 1946-1964 – meaning they range in age from 46-64 years of age.

Retirement is certainly on their minds and they are concerned about how much they need for retirement savings.

As baby boomers approach the magical age, there are some pretty important things to keep in mind about saving for retirement.

Let’s take a look at five things to keep in mind about retirement savings:

Retirement Savings Is Up to You!

Ok, so this is no breakthrough – I’m not pretending to discover a cure for cancer by any means, but this point needs to be stressed over and over again.

Years ago, you could work for an employer for 30 or 40 years, retire with a nice pension provided by the company and collect your social security and be pretty comfortable in retirement.

Not anymore!  Companies are dumping their pensions left and right, Social Security will need a massive overhaul to avoid going defunct – so what does that mean for you?

You are on your own for retirement savings – and that’s OK.

When Can You Access Your Retirement Savings?

This is something that all baby boomers should get really familiar with.  Accessing your retirement savings is generally what’s going to provide you an income in retirement, unless you have other business income etc.

Most people recognize 59 1/2 as the magical age to access your retirement savings, but get familiar with the rules surrounding your withdrawals.  Here’s a couple of them to remember:

• You can access your IRA at any time, but be aware of the penalties.
• You can withdraw from your 401k savings prior to 59 1/2 without penalty if you are at least age 55 when you retire.
• You can take out Roth IRA contributions at any point in time, but the earnings must left alone until age 59 1/2.

What is Your Retirement Savings Number?

A few years back, Lee Eisenberg wrote a book called The Number, where he talks about what you’ll need for the rest of your life and what it will cost.  It’s an entertaining and informative look at what the rest of your life will look like.

You should be asking questions like, “Is a million dollars the magical number?”  Many people think they need much, much more than that, but is that right?

In light of this, you’ll need a good retirement calculator and you’ll want to sit down with your loved one and figure out your income versus expenses and determine how much retirement savings you need?

How Will You Diversify Your Retirement Income?

This is one that boomers probably have in the back of their minds, but some careful consideration should be done.

Will you have a pension, social security, 401k savings, IRA money, or annuities to help supplement your retirement income?

What about starting a business or turning a hobby into an opportunity to make some side money?  Have you considered other ways to make money and diversify your income in retirement?  You probably should.

Once again, retirement savings is up to you, therefore you need to be prepared and should have multiple lines in the water so that you’re not relying on the fish always biting from one particular source.

How Will You Diversify Your Retirement Savings From a Tax Standpoint?

Tax diversification is extremely important and is something that everyone should get familiar with and take a look at for their own situation.

In essence, tax diversification takes a look at the tax status of investing into three different vehicles.  You have tax-deferred, taxed-as-you-go (or non-qualified) and tax-free.

No one investment vehicle is right in every circumstance, but I think it’s very important to spread savings out among these three types of accounts because the greater the flexibility you have for accessing retirement savings, the greater the options you have for lowering your tax burden in retirement.  Plus, after reading why tax-deferral may not be all that it’s cracked up to be you might agree with me.

If taxes are high in some years, you have other money to withdraw from besides your 401k.  If tax rates are low, then why not pull money out of your IRA and consider a Roth conversion etc.

How About You?

Readers, what are some other things to consider for retirement?

There’s no question that 401k’s have become the norm for retirement savings.  More and more companies are putting the responsibility of saving for retirement on the employee and have gotten rid of traditional pension plans.

401k Popularity

According to a 2007 Hewitt & Associates survey, 64 percent of plan sponsors said they use a 401k for their organization’s primary retirement-savings program. That’s up from about 35 percent just 10 years ago.

Not only do employers like the 401k, but many employees love them as well.

Why people love their 401ks

Ease of Use

Most 401k plans are pretty easy to sign up for and begin saving into.  A couple forms, a couple signatures and you’re on your way to putting a percentage of your income away for retirement!

Bigger contribution limits

Unlike Traditional or Roth IRAs, which cap your contributions at $5,000 (with a $1,000 catch-up contribution if over age 50) the 401k allows up to $16,500 with a $5,500 catch-up contribution over 50!

If you’re making a good income, this is a great way to get additional money saved up for retirement.

Tax treatment

Contributions are tax-deferred, which means you don’t have to pay taxes on gains each year.  They are deferred until you withdraw your money in retirement.

Not only can you defer your taxes, you can also take a deduction on your contributions.  In other words, you get to deduct (or subtract) the amount of your contributions against your ordinary income.

That’s a pretty sweet deal.  Say you make $80,000 and put away $16,000 – your ordinary income is reported to be $64,000!

Why you shouldn’t love your 401k!

Limited Control

Here’s what I mean:

1. The employer chooses which company you will use (i.e. Fidelity, Vanguard etc)
2. In general, the employer chooses which funds you can pick from (you may only have 15-20 options)
3. You only have 11 years to control your withdrawals (59 1/2 – 70 1/2 – there are penalties for withdrawing before that and penalties if you don’t withdraw after that).

Government Forced Withdrawals

Many people don’t realize this – but at age 70 1/2 the government forces you to take money out of your 401k (unless you’re still working).

How can the IRS force you to take money out?  By whacking you over the head with a 50 percent penalty for not taking the withdrawal!  50 percent!!

So all that money you’ve managed to save up for retirement – and perhaps you don’t need – you MUST withdraw.  Why would the government do this?  To get tax revenue silly!

401ks are Tax Infested

This is the biggest reason not to fall in love with your 401k.  All those taxes you deferred for all those years have to be paid some time.

People often assume their income will be lower in retirement and therefore their tax bracket will be lower – which means that they’ll pay less taxes.

That’s not necessarily true.

You’ll probably want to maintain your standard of living, which means you’ll need the same amount of income.  Factor in inflation and depending where tax rates are - you could actually be paying more in taxes than you ever imagined!

That pretty balance you had on your 401k statement isn’t really yours.  You may be giving 25 percent or more back to good ol’ Uncle Sam.

These things are loaded with taxes.

If you pass away, your beneficiaries are forced to take money out (again think penalties here) and will have to pay ordinary income tax on every single dollar that’s pulled out at whatever tax rates apply to them!

What should you do?

Use it wisely

The last thing you want to do is throw the baby out with the bathwater as the ol’ saying goes.  The bottom line is you need to use the 401k wisely.  If your employer is matching contributions – you want to definitely take advantage of that!

Make informed decisions.

Take a look at your situation to determine if you’re creating a tax-infested monster.  Crunch some numbers to determine if using a Roth IRA or Roth 401k is better for you.  There’s some handy calculators out there that will help you figure this out.

Diversify

Diversify yourself from a tax perspective.  In other words, make 401ks and IRAs, taxable accounts, municipal bonds and Roth 401ks and IRAs a part of your overall tax strategy.

Bottom Line

Don’t get caught up in the hype of 401ks.  That doesn’t mean you don’t use them, but just don’t fall in love with them!  Make informed decisions and understand what you’re saving into.

What about you?  Are you in love with your 401k?  What have you done to diversify yourself?