July 26, 2005
Tuesday

In this day of do-it-yourself pensions, almost half of those with tax-favored 401(k) retirement savings plans through work cash them in when changing jobs instead of holding onto their retirement nest egg.

A new study of more than 200,000 corporate employees with tax-deferred 401(k) accounts finds that 45 percent cashed out upon quitting - compared to 32 percent who left the account with the former employer and 23 percent who transferred the money to an Individual Retirement Account or other retirement plan.

"With fewer workers tending to remain at one company until retirement, employees may become serial consumers of their 401(k) savings, which can have serious consequences when it comes to their ultimate ability to reach their retirement goals," said study author Lori Lucas of Hewitt Associates.

The survey by the benefits consultant also found that:

- Although 66 percent of workers 29 and younger cashed in 401(k) accounts, 42 percent of middle-aged workers did, as well.

- Almost 73 percent of workers with 401(k) balances of less than $10,000 cashed out, but so did 31 percent of workers with larger accounts.

The study comes as President Bush is proposing that Social Security retirement benefits be lowered for all but the lowest-income workers now younger than 55 to keep the system solvent.

At the same time, employers continue to eliminate the traditional defined-benefit pension. There are about 30,000 of these plans now in the United States, down from about 101,000 two decades ago.

The resulting shift to tax-deferred 401(k) and other contributory plans puts new pressure on workers to save for retirement. Such programs enjoy tax breaks, but Uncle Sam has strict rules job changers should consider before cashing in the accounts.

Tax law gives workers 60 days to arrange to leave the money in the plan of the former employer or have it transferred directly into a new employer's plan or rollover IRA, with the employee never touching the money.

But if departing workers with $5,000 or less in a 401(k) don't leave rollover instructions, the money will be transferred to an IRA of the employer's choice, and not one of the 5,000 IRA mutual funds among which the employee might choose, the Financial Planning Association reports. And employers can still cash out accounts of $1,000 or less, according to the association.

Should the worker get the 401(k) rollover money in hand, even briefly, 20 percent is automatically withheld for taxes even if the rest goes to a rollover IRA.

Workers who hold onto the check to pay credit-card bills, put a down payment on a house, buy a car or take a vacation will owe full federal and state income taxes on the money, plus a 10 percent early-withdrawal penalty if the person is younger than 59-1/2, reports pension expert Nick Kaster of the tax publisher CCH Inc.

All these rules make rollovers ripe for costly mistakes by job changers, retirees, former employers and IRA trustees. Almost $2 trillion will be rolled over from workplace plans to IRAs in the next five years, according to Financial Research of Boston estimates.

Mutual-fund giant T. Rowe Price - www.troweprice.com - has a rollover-IRA kit plus interactive CD-ROM to walk job hoppers and new and soon-to-be retirees through the process.

"With job tenure decreasing and the population aging, more people will be confronting these choices," said T. Rowe Price's Brian Lewbart. He said anyone looking to roll over a 401(k)-style plan should:

- Get two copies of a distribution form from your 401(k) plan administrator.

- Send one copy of the completed form to your plan administrator and send the other copy to the mutual-fund or brokerage house to which you are transferring the retirement account.

- Establish the account at your mutual fund or brokerage, and forward the rollover IRA account number to your 401(k) plan provider.

- Enclose a copy of your latest 401(k) statement with the paperwork you filled out to open the rollover IRA account.

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