5 Ways to Resurrect Your 401(k) Money

By Ron DeLegge, Editor

November 20, 2008

SAN DIEGO (ETFguide.com) – More and more workers find themselves having to deal with a host of major financial decisions they thought they wouldn’t have to make just yet. For example, now that I'm leaving my job, what do I do with my 401(k) retirement plan? Do I let it die?

Just this week, Citigroup (NYSE: C) joined the great job reduction movement of 2008 by announcing it would slash 52,000 worldwide jobs. This comes on the heels of mounting job losses in multiple industries across the country. The U.S. Department of Labor reports that 1.2 million jobs have already been lost during the first 10 months of the year. What will happen to the 401(k) savings of all these workers? 

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Hopefully, people won’t make savings blunders that cause themselves grave financial pain.

If you’ve taken an early retirement, been let go, or otherwise left your job, listen up: Take good care of your 401(k) retirement plan and it will take care of you.

Here are a few tips to help you to achieve that goal:

1. Communicate with Your Employer

If you've recently left a job or are planning to, the first step to resurrecting your 401(k) plan is to ask your employer for a retirement distribution form. By signing and completing this document, you will direct your employer how you wish to have your 401(k) savings distributed to you. It’s vital that you complete your distribution form with accuracy and diligence, to avoid later headaches.

If it’s your decision to do a direct rollover or transfer of your 401(k) plan to an individual retirement account (IRA), it’s advisable to have your IRA already established with a bank or another financial institution of your choice. This will help you to avoid some of the distribution problems mentioned below.

2. Know Your Distribution Options

Retirement distributions taken before age 59 ½ are usually not a good idea. For one, a good part of your proceeds will go to go to pay for income taxes on the amount you take, plus you’ll pay an additional 10% early withdrawal penalty to the IRS. It's not uncommon to see some 401(k) participants net 60 or 70% of their actual distribution amount!

If you need to access your retirement funds and you’re just a few years away from 59 ½, you might want to consider applying for a distribution under the IRS’ Rule 72(t). While the rule allows you to sidestep the 10% early withdrawal penalty, your withdrawal is still taxed at your income rate. The drawback of using Rule 72(t) is that you jeopardize your retirement future by raiding your account.

3. Avoid Big Money Mistakes

Many terminated workers are surprised to learn that their unpaid 401(k) loans convert into taxable income. Why? Because failing to pay back an outstanding loan in a 401(k) plan before distributing or rolling over your funds triggers a nasty tax bill. Proceed with caution.

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Also, distribution proceeds paid directly to you is subject to a 20% withholding tax. This can be avoided by opting for a direct rollover that’s payable to a financial custodian who accepts your 401(k) money on your behalf. Which do you prefer? Having 80% of your rollover money or 100% of it? Taking 100% of your money is the better choice. Sidestep the withholding tax by opting for a direct rollover.

4. Don’t Leave Your Money Unattended

Leaving your money behind at an old job is usually not a good idea. It limits your investment options, restricts your beneficiary distribution options, and can complicate your life. On the other hand, rolling your money into a self-directed IRA can allow you to have greater flexibility and control of your 401(k) money along with lower investment costs and a broader menu of choices.

An IRA with a brokerage window will allow you to build a simple but diversified portfolio to low cost investments like exchange-traded funds (ETFs) that are indexed to major market barometers like the Dow Jones Wilshire 5000 (NYSEArca: TMW), the S&P 500 (AMEX: SPY), MSCI EAFE (NYSEArca: EFA), MSCI Emerging Markets (NYSEArca: VWO) and the Lehman Total Bond Market Index (NYSEArca: BND).

After you’ve built your portfolio on a rock-solid foundation of market indexes, feel free to experiment a small part of your retirement funds on other investment strategies like picking active funds, inverse/leveraged funds, individual stocks or fundamental ETFs. Be sure to experiment only with the portion of your retirement money that you can afford to lose. The rest (your serious money) should be indexed to the market.

5. Build Your Retirement Portfolio

Successfully managing your retirement money doesn’t necessarily require a lot of time, but it does require attention and diligence.

For example, making sure your money is allocated in the correct asset classes along with the funds or ETFs that best represent those areas is important. Periodic rebalancing can help you to stay on course. Also, minimizing your trading activity to smart activity, versus dumb activity, is another important cost advantage that too few ETF investors fail to do.   

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What's the financial payoff? The stellar performance for two of ETFguide’s portfolios, the Capital Defense and Sector Savvy, clearly proves that having the right mix of ETFs can and does lead to intelligent results. On a year-to-date basis, both ETF portfolios are beating the S&P 500 by more than 25 percentage points. And even more, these two ETF portfolios are winning with an aggregate portfolio cost substantially less than 95% of actively managed mutual funds. It’s possible to have success even during difficult markets!

Making the most of investment tools such as these and Yahoo Finance’s ETF screening tools can help you to make intelligent financial decisions for your 401(k) and IRA retirement funds.