Whats a 401k rollover?

All right. First off is what is a rollover? A rollover is just simply a tax free transfer to another qualified plan, right. So, what I’m saying to you here is that if you leave your employer for instance, and you can take your 401(k) with you.

Sometimes that doesn’t happen because people don’t understand that they have the availability to do that, and it’s a tax free distribution of your program. As long as you put it into a like kind of program, it’s going to be a tax free transfer.

You can put it into another qualified plan like a 401(k), or you can put it into an IRA- and there’s reasons to do both. We’ll discuss those as the program proceeds here.

Types of qualified plans are obviously the 401(k). This is the most common type and most known plan typically with publicly traded companies. Any company that has a stock ticker symbol, they’re typically going to have a 401(k) type of program.

Privately-held companies will carry 401(k) plans as well, same thing with the privately held companies. This conjures up in many small business folks that aren’t necessarily traded or aren’t traded on the stock exchanges, small CPA firms or legal counselors or doctor offices- things of that nature- any small business plumbers, electricians and often with 401(k)s are a profit-sharing plan.

Now, in a 401(k), you’ll make a contribution predicated by what the IRS says you can do and what the plan allows you to do. If you’re lucky, your employer will add money to that. They’ll make an additional contribution for you, and it often has limits, and they won’t go above a certain amount. Now, once they determine that the plan is going to make X, Y, Z contributions, those are pretty much concrete and will occur. The profit-sharing part on the other hand is not. That is a discretionary based on the employer or the plan custodian, the owner of the plan’s profits. All right.

403B

So, the next kind of plan then will be the 403b. These are typically in not for profit organizations like schools, universities or charities.

You know, if you’re a teacher you have a 403b. 403bs are fairly conservative plans. They have a few different rules, but they act similarly to the 401(k).

There’s a few different caveats associated with them, but overall you put money in and deduct it from your taxes. 457 plans are for State and local governments.

These plans have caveats as well. They’re different than the 403b and the 401(k)s then we got the TSP plans. It stands for Thrift Savings Plans for government and military employees. This is a program that’s very similar to the 401(k) but simpler, and has different caveats as well.

So, each- like I said earlier, each of the programs individually, each 401(k) is going to be different. Each TSP may not be different. They’re all be the same, but they act in similar fashions.

Then there’s the IRA. This is a personal plan and it’s individual retirement account is what that acronym stands for. What we see with IRA’s is they come up in people that work for an employer that does not have a plan in place or for retirees that roll their plans over or even non-retirees.

As I said earlier, you can roll it over to a current plan, a new plan or you can roll it over into an IRA -there’s reasons why you would do both. There are many plans that work similarly to IRAs typically for the small business owner, and there are simple IRAs and there are SEPs or Simplified Employer Pensions. Keoghs were the very first ones that came out.

Again, there’s many different types of plans out there. They all work similarly, but what you see on your screen are the big ones.

When can you take money out of your 401k?

All right. So, let’s talk about the eligibility for rolling over your money. When are you able to access the money? That’s really what we’re discussing here.

One reason is that your company went out of business. If your company goes out of business, that’s a termination of the plan and you’re able to have access to that money. You can really have access to it if you want to, but that would be disadvantageous if you were to cash it up.

So, like I said earlier, you can move that money into the new employer that you go to. Let’s say that you don’t have to physically move anywhere. Your company got bought out or sold and you’re still in the same building, you know, doing the same kind of functions.

It’s just a different name to it. Well, that would be a reason to have access to your money.

One plan changed, and it goes into a new plan on the assumption that the new owners of your business have a plan. So, you can take your old 401(k) and move it into the new program.

A caution here: The one plan may have more favorable benefits than the other plan, the second plan. So, the plan you’re moving from may not be as beneficial as the plan you’re moving to. In that case, that’s good. What we see as a problem, is that the plan that you have currently is more beneficial than the plan that you’re moving to.

So, you think you have benefits that you don’t have anymore, and then you implement on a cause issues. Those can be mistakes that can be avoided simply by understanding where that money is going. Now, you can move your money to the plan that’s coming in with the new employer or to your new employer’s plan, or you can move it to an IRA.

You have choices there, and there’s reasons to do both, depending on how old you are and your circumstances.

Now, you might be the one, your company is still in business; but you want to change jobs and you want to go to a new company. Well, that’s a termination of employment and a reason to do a rollover. Now, you might just change jobs, move to a different employer or something and that’s in termination of employment, thereby giving you an option to roll your plan over and same thing applies.

You can go to the new employer with the money and use their 401(k)s, just understand the rules or you can move it to an IRA. Okay. Retirement is another reason to making you eligible. That’s an obvious one. Now, in this case, you may not have a new employer to move your plan to.

What we see; however, and we believe is a mistake, is that you leave your plan with your employer that you retired from. This often isn’t to your advantage to do so and requires some planning and guidance. So, retirement is another reason to making you eligible to have access to your money. Then illness of course, yeah, you may not want to terminate your plan; but you just may get sick, and that of course is a reason to access the funds.

Well, okay, let’s get into the meat of the program here, and we’ll start talking about the mistakes. As you can see on your screen, the very first mistake that we see, and it’s one of the biggest ones I think that can cause failure of any retirement plan, is having too much in any one company stock.

Now, there are reasons why, and I’m just going to bring up the next bullet point here is Enron. In the days of Enron, their corporate plan, their 401(k) plan only allowed Enron stock to be put in it. Those days are far gone and it’s predominantly because of this. Enron, it made a decision and as I said earlier, all 401(k)s have different caveats, the IRS has rules and as long they work within those rules, they’re okay. At this particular point in time, the people that worked at Enron could only have Enron stock in their company.

Today, there’s percentages that the IRS says that they can mandate. Okay, however, that still can lead to too much investment in the company that you’re working with, and why that’s bad is glaring at you on the screen. Impropriety is the lie behind it. We never know when the next Enron is going to come.

So, if your company pays their matching contribution to you in stock, they might be on an annual basis in compliance with what the IRS mandates; but over time could build up to a substantial amount and you could be heavy with respect to the investment in that particular company stock.

Holding too much company stock is actually worse than holding too much in a particular sector, technology sector, energy is a sector. There’s different sectors with respect to what you can invest in. If you have two heavily weighted into one particular sector then, you know that’s the second biggest risk that you can come to because we never really know where the next bubble is going to be.

The housing bubble came up and bit us all somewhat by surprise, and yet your 401(k) may not have had any investment in this particular sector; but yet it affected you, and it’s because that affects everything else.

So, we have to be very diligent and very conscious about where the money is positioned. In relationship to the company stock, there is unrealized appreciation. There’s two different kinds of taxes.

Long-term capital gains tax, which currently is 15% and I believe Congress just extended that for a couple of years so we can reasonably expect that they stay at 15%. If your tax rate, income tax rate is lower than 15%, this doesn’t make any sense.

If it’s higher than 15%, you may want to capture some of those unrealized appreciations. What is that? That’s a stock that’s owned, let’s say it’s Enron, that you purchased for or you were paid with respect to their company contribution, their match and it was valued at a dollar.

Today, it’s worth $10. There’s a $9 unrealized appreciation. It grew in your 401(k), growing like that in a tax deferred basis. Well, if the tax rate you know as 15% and you’re in a 30% income tax bracket, it might make economic sense to take that stock out of the 401(k) and cash it in and pay the tax on it; because 15% is better than 30% and then of course, you have all the strings that are eliminated from those dollars as well.

Now, having said what I just said, you’ve got to be careful. You have to be over 55 for certain. You’ve got to be under 59½ so you don’t get a 10% penalty.

Seeking advice of a professional that’s in the 401(k) or a qualified money business or your tax advisor would be the right and appropriate step to take care, but it’s a strategy that can be used. Sometimes it makes a lot of sense to use. So, just something for you to think about.

Number three is a way to minimize taxes. Eliminate the problems that are inherent inside of the 401(k)s with respect to mandatory distributions and all that.

So, it’s just a strategy that I wanted to present to you that makes sense for some folks. Why do people invest in the company that they work with and solely in that company? It’s because of devotion. You know, they feel obligated or emotionally tied to the company for some reason; and a investor money in it and over time this can come back to hurt you and bite you pretty hard. We’ve seen it many times, over and over again- nationally throughout the country. So, that’s mistake number one, too much in company stock.

Okay. Well, mistake number two is asset allocation. No asset allocation. We spend a little time in mistake number one discussing this; and what I’m referring to here is not having a wide mix of asset groupings that you’re invested in.

Only Enron stop obviously was a problem. That’s no asset allocation. Even today we still see this in many many programs. Poor asset allocation: What this is being referred to is, how do we pick what we’re putting our money in and we do several different things.

First and foremost, we hear conversations in the office, in the shop or wherever it is you work. You talk to your neighbors in the next cubicle or around the coffee machine or water cooler, and you discuss things like this.

So, you make decisions based on those types of discussions or you get to shake, you’re a little more diligent, you get to shake that the provider is giving to you when you look at the performance of all the funds that are there; and you poke and hope for all practical purposes, and you look at what it did last year and hopefully it’s going to do the same thing this year.

There are studies that will prove that strategy false. It fails more times than it succeeds. So, if you’re picking what was good last year, the fund or the manager often in the coming years is on the bottom of the success pile if you will.

Poor asset allocation is taking advice or no advice and poking in the dark and hoping for good results. No strategy for growth: What this is referring to is having a plan to capture gains.

What plan did you have in 2008 to capture gains?

On October 9th of 2007, our marketplace hit a historic high. That’s historic, never been higher. We were making more money than ever but nobody has a strategy to exit and capture gains. Everything was left there for risk. Everything was left there to happenstance.

There was no strategy on the way up to capture any gains. My suggestion to you to avoid this mistake is to create a strategy for yourself. All investments, all brokerage, all investments have a safe place to put money, and it’s typically on money market accounts.

So, you can put it there and keep it safe, and then strategize from that point. So, have a plan to capture your gains. This one, number four, says no exit strategy. Have a plan to minimize losses. Most people don’t have a plan. They wait until it hurts bad enough to get out.

So, here’s what I’m saying to you. If you have a plan to capture your gains, you’re not really going to need too an aggressive of a plan to minimize losses because you will have captured money in a safe place and you can strategize from there.

The folks that are winning today are the ones that had a strategy. They were out of the market at or around the top of it, and now that the market it’s at the bottom, they’re buying low and selling high. That’s the goal. How do you do it?

In one way, I’ll submit to you. If you have a strategy to capture gains, you’re not going to need a big strategy or an aggressive one to minimize losses. Those are just the realities of investing.

The goal is to buy low, sell high. Don’t be invested to have only in one anything and have a strategy to conquer your investment portfolios with respect to growth and minimize losses.

• Mistake number 3

early withdrawal, this is – and most people understand that there’s a charge for getting out of the plan early, but they don’t understand what that means.

Now because the money is tax deferred and deductible when you put it in, there’s a string attached. This string says that if you’re below or younger than 59½, you are going to pay a 10% penalty.

It doesn’t sound too bad, but if you take money out of a qualified account 401(k), all of the things we’ve been talking about- you’re going to pay tax plus a 10% penalty.

That’s called an early withdrawal charge. Now, it might be necessary that you do so, but it’s certainly not advisable that you do so. It’s a pretty hefty charge on top of the taxes. Now, this applies to everybody except those folks in the 457 plan. It doesn’t apply to them.

So, this is a good thing if you’re a State and local and Federal employee, you got a 457 plan and you can technically take the money out at any time, pay tax but you won’t have a 10% penalty and that’s a good thing. So, if you’re 25 years old, let’s say you got a good investment portfolio.

You’ve been diligent about it, you can take money out and diversify outside of the 457 plan and not pay a penalty by doing so. So, if you put that back into a qualified plan as well, a like kind plan- in this case it would be an IRA, you won’t pay a 10% charge.

So, that’s just something, a little caveat that those 457 people should know about. There is the age 55 rule. If you’re over 55 years old, most 401(k) plans today will allow you to avoid the 10% early withdrawal charge by giving you an option to have an in-service withdrawal.

This applies to 401(k)s with 403b plans. So, those of you that are over 55 or approaching retirement and you want an additional diversification with respect to your portfolio, you can take out a percentage of your 401(k) or 403b plan. It’s called an in-service withdrawal. You’re still working. You’re still contributing, but you’re able to take a piece out. That’s what that refers to. Mistake number three is not knowing that you can do all that.

Mistake number four will just be the last one for this segment. It’s cashing out of the plan early. Why do people do this? Well, what we’ve seen is people cash out of their plans early to buy the hottest investment center on the marketplace.

We saw this in the early 2000s, mid 2000s with respect to the housing. People were investing money in houses because the returns were so good. Like any investment, if you’re making money some place, not everybody can make money; somebody is going to lose eventually, and that’s referred to today as “the housing bubble”.

Now, there’s been a study done that said that most folks under the age of 65, that had $100,000 or less in their 401(k), cashed amount to chase the returns in the housing market. Now, hopefully, those succeeded, but I’m certain that not all did. So, this is a mistake, chasing the hottest investment out there with your qualified money.

People do it. Real estate is one. I popped up on the screen there gold because this is just something that’s very pertinent with respect to the discussions today.

Today, gold is being sold as investment option. I’m not going to offer an opinion at this particular point in time; but it’s a commodity, so you need to understand your risks- what you’re buying, why you’re buying it. That’s the most important thing.

What’s the next biggest and hottest investment that’s coming down the road? You know I don’t have a crystal ball, but I’m certain that there’s going to be one. Just make sure that you understand the risks involved and the cost of cashing out of your plan to chase hot investments.

Well, okay, we’ve just finished Module I of the eight biggest 401(k) mistakes and how to avoid them. I’ve enjoyed going through this module with you and I look forward to seeing you on Module II.