Jason Stipp: I am Jason Stipp with Morningstar. July's job report showed some glimmers of hope, but week by week we still see a lot of volatility in initial claims, which tells us that the job market is still very unsettled. One of the things that this can cause is a lot of people in-between jobs or looking for new jobs.
And here to talk with me a little bit about the investing implications of being between a job is Christine Benz. She is Morningstar's director of personal finance. Thanks for joining me Christine.
Christine Benz: Hi Jason. Nice to be here.
Stipp: So if you are laid off or you are looking or a new job, one of the questions that might come up is what should I do with my company-sponsored plan, my 401(k) plan, from my old job? What are my options?
I know potentially one of those options to someone just laid off might be, "Well I should cash it out because I need that cash." So what should I be thinking about if I am between jobs right now with my old retirement plan?
Benz: You are right Jason. That probably is a huge temptation for people eyeing that 401(k) balance, thinking, "I could just take the money and run." People will probably know this, but there are huge implications in doing that. You face a penalty and you also have to pay ordinary income taxes.Read Full Transcript
So by the time you take the cut out of that balance, you are probably looking at about half of what you have in there. So really think twice about doing that. Not only do you take that haircut on your withdrawal, but you are really short-shrifting your own retirement.
So generally speaking, that is a terrible idea unless you have got some other dire situation going on in your life. For example, you are about to be shut out of your home or something like that.
Stipp: So absolutely last resort.
Benz: Yeah, last resort.
Stipp: So what are my other options then with that money, assuming I want to keep it invested? Should I just leave it where it is, or what else might I do with those funds?
Benz: That is definitely an option for most investors, to just leave it with the old 401(k) plan. For most investors I would say probably a better idea is to think about a rollover into an IRA.
The reason is that oftentimes you will pay some administrative costs to keep your money in the plan or to invest in a 401(k) plan period. And you will also have a lot more investment options to choose from if you are investing within the context of an IRA. You can really put anything into an IRA, and that is another important advantage.
Stipp: So if you are rolling over to a traditional IRA, you might also have the option to turn that into a Roth IRA, potentially. And what are some of the benefits of that?
Benz: Well the key benefit, and I think it is actually a great idea for someone who is in a position to make the conversion once they roll over to a traditional IRA then, to think about doing a conversion to a Roth.
The key benefit is that you will not have to pay taxes upon your withdrawals in retirement if you have your money in a Roth. So that is obviously the key advantage. And also, you will not have to take mandatory withdrawals when you are in retirement. You can let that money grow and build and possibly pass it on to your heirs.
So I think those are a couple of key reasons to consider a Roth. And one of the reasons you might want to consider it if you have lost your job is that you will possibly be at a lower income level, and that means that the tax hit that you will pay when you do that conversion--so you will have to pay taxes when you make the conversion to the Roth--the tax hit will be that much lower because you will be in a lower tax bracket.
So it is something to consider, but you need to make sure that you have the money on hand to pay those taxes rather than pulling it out of the Roth to pay the taxes.
Stipp: So it could be a great benefit, but certainly a lot of considerations beforehand.
Benz: Check with an accountant, I would say.
Stipp: OK. Another thing that a lot of people have from their old jobs is company stock. They might have gotten it as some sort of award for part of their compensation. How should I think about the company stock? I am not working there anymore, so should I just sell it or should I hold on to it? How do I factor that into my portfolio planning?
Benz: Probably the same rules that apply to anyone who is currently employed with a company and has company stock would apply to someone in this situation. So my advice would be to limit company stock, whether you are employed with the company or not, to less than 5% of the portfolio. Otherwise you are simply taking too much risk by investing overly with a single company. So I would limit the position if not liquidate it altogether.
Stipp: So really ... make a decision looking at everything all at once and seeing where that fits into your overall scheme.
Benz: That is right.
Stipp: OK. So if I am lucky enough to find a new job, and we hope that the job market recovers and more new jobs come online, I am going to have, hopefully, another employer-sponsored plan. So what are some of the things I should evaluate on that new plan in deciding then what to do with my investment dollars that I have had in this transitory time?
Benz: The key thing I would look at is whether you are earning a match on that plan. So I would check either with the HR administrator or look in the summary plan description to see what the rules are related to matching contributions and whether you are getting matched at all.
For most people, if they are not getting matched on the 401(k) contribution, it is actually probably a better bet to start by contributing to a Roth IRA instead because of the tax treatment that we discussed, and also because of the opportunity to invest in a broad array of investment vehicles.
So the match is the key thing I would check up on. After that, assuming you are earning a match, also check up on the quality of the investment options, and Morningstar obviously offers a lot of good tools for doing that.
Stipp: Great. Well thanks so much for your time Christine. It was great talking to you.
For Morningstar I am Jason Stipp. Thanks for watching.