401(k) accounts have recently become a very hot topic in the media. Now that our economy is officially in a recession, many of you have felt the effects of the recession in your 401(k)’s because of the falling value of stocks. Many 401(k) programs do not allow you to shift from one investment to another quickly in response to the changing market conditions. For those that do, I hope you were able to take advantage of that by putting some of your retirement savings on the sidelines in a good money market fund within your 401(k).
I’m sure most of you understand the basics of a 401(k). A 401(k) is essentially like a Traditional IRA (Individual Retirement Account) that is administered by an employer. I say like a Traditional IRA because a 401(k) is funded with contributions that are deducted from your current income and when you finally take distribution of your 401(k) funds, the distributions are considered ordinary income and are taxed on your yearly 1040 form.
Because of this, if you were to ever leave the job where you’re contributing to this 401(k), you are able to then transfer the assets in your 401(k) to a Traditional IRA, at an IRA custodian of your choosing, without having to pay any taxes or incur any penalties for early withdrawal. You can do this because of the basic similarities of the account types.
It doesn’t matter how you leave the job either. You can leave voluntarily or involuntarily. In this new recession, especially here in Michigan, I unfortunately have quite a few friends and acquaintances who have recently lost their jobs, many of whom have substantial assets in their 401(k)’s. They are now eligible to move their 401(k) assets to a new Traditional IRA.
Sometimes, companies sell portions of the company to other companies, and the employees involved now have effectively changed employers. In most cases, the 401(k)’s stay with the old company and become eligible for transfer to a new Traditional IRA.
To be sure, this is one choice of many the employees have for dealing with their 401(k)’s when leaving a company. For instance, if the assets in the IRA are greater than $5,000, the former employer must continue to administer the former employee’s 401(k), if the employee so desires. Also, the employee has the option of rolling over the assets of the 401(k) from the previous employer to the new employer’s plan.
But transferring the old 401(k) to a new Self Directed IRA opens up a whole new world of investment opportunities. In a 401(k), you are restricted to investments that are available to the 401(k), usually a small set of mutual funds as well as the company’s stock. Even in a “regular” IRA, administered by a brokerage house, you are limited mostly to Stocks, Bonds, and Mutual Funds for your investments.
In a Truly Self Directed IRA, you not only open the doors to all stocks and mutual funds, you also open the doors to a whole array of alternative investments, including Real Estate. If you have expertise, for instance, in renting properties, you may want to try that in your Self Directed IRA, where all the profits can accrue on a tax deferred basis.
If you don’t have the expertise, but know someone who does – AND you trust that person — you could participate with that person in their Real Estate investing and earn a very nice return for your IRA in the process. The benefits of this kind of investing can be great. My favorite, given today’s very volatile stock market, is that you can get a very steady rate of return and not be subject to the roller coaster ride that most stock investors are on at the moment. In 401(k)’s you don’t have this opportunity.
The bottom line here is to be aware that there are other alternatives for your 401(k) besides keeping it in the 401(k) when you leave a company. Alternatives that could ultimately give you far more flexibility and much better returns than what you’re seeing now.
