Three Ways to Protect Your 401(k) in a New Job

The first in this two-part series looks at some ways to protect a 401(k). The second part will cover medical benefits.

At any given time, millions of Americans are in the process of changing jobs, with millions more thinking about taking the leap.

The average U.S. worker has held 10 jobs by the time he or she hits age 40, U.S. Secretary of Labor Elaine L. Chao recently noted.

When you move from one job to another, you have the opportunity to improve your financial situation on several fronts.

But job changes can be complicated. If you're not careful, your 401(k) and medical benefits can suffer some damage in the transition.

When you leave a job, you might be tempted to cash out your 401(k) plan. That's a bad idea. If you're under age 59 1/2 -- as most people who change jobs are -- you'll have to pay a 10% penalty for taking an early withdrawal.

What's more, you will have to pay taxes on the money you withdraw -- and the money might push you into a high tax bracket, making the hit even worse. And you'll give up the potential for future tax-deferred growth on those savings. In short, you'll be shooting yourself in the foot.

Here are three options that make more sense:

1. Leave your money in your former employer's retirement plan.

Most employers will give you this option as long as you have at least $5,000 in your 401(k) plan. This option may be a good one if you won't immediately be eligible for your new employer's plan -- or your new employer doesn't have one. Otherwise, most financial advisors recommend consolidating your retirement savings into your new account for simplicity's sake.

2. Roll your current 401(k) or other retirement savings plan into your new employer's plan.

Ask your new employer when you will be eligible for the firm's retirement savings plan, and find out what you should do to facilitate the transfer of assets from your old plan to your new one.

Make sure that your old employer writes rollover checks to your new plan administrator -- not to you. Reason: If the check is in your name, the plan administrator must withhold 20% of the account balance for taxes.

True, you can get that money back when you file your income taxes, but only on two conditions: You must deposit an amount equal to 100% of the original amount into your new account, and you must do so within 60 days of receiving the check. That means you'll have to come up with 20% out of your own pocket while you wait for your refund!

Worse, if you fail to make the rollover within 60 days, the transfer will be treated as a withdrawal -- which means you'll owe taxes on all of it, and you will have given up the chance to defer future taxes on the money those savings earn.

Your new employer will give you a form that lets you select "direct rollover" (or something similar), which means that the money will go directly from your old account to your new account.

3. Move the money from your old employer's 401(k) into a rollover IRA.

A rollover IRA might be for you if your new employer doesn't offer a retirement savings plan. Again, make sure the check is written to the new account rather than to you. That way you'll avoid withholding -- as well as the risk of missing the 60-day deadline and being forced to pay taxes on the full amount.

Keep your rollover IRA separate from any other IRAs and don't make any new contributions to it. (You can maintain another IRA for future contributions.) That way you will retain the option of rolling the money in your rollover IRA back over into a future employer's retirement savings plan.

Next part: Protecting your health benefits.