Is it in your best interest to take a lump sum distribution?

First of all, if you have a defined benefit plan (a pension), unless you are chronically ill you should NOT take the lump sum distribution. It is always in the company’s best interest to get you to take the lump sum distribution as the company’s obligation to you ceases right then and there.  You, on the other hand, want a “sure thing,” a guaranteed monthly check for the rest of your life.

Having said that, the remainder of this article will consider lump sum distributions from defined contribution plans (ex: 401K).

Options on what do you do with your retirement account upon a job change?

• You can transfer to the 401K at your new employer.
• You can transfer the money to a traditional IRA.
• You can transfer to a ROTH IRA.
• You can take a lump sum distribution.

If you transfer to a 401K at your new employer (the easiest and most seamless option) you need only tell your current plan administrator and provide them with the specifics of your transfer (new employer account info) and you are done. This is the best choice if you have no knowledge or desire to manage your own retirement accounts via a self directed IRA. When deciding which transfer works for you a big determining factor would be if your new employer has a matching contribution, some do, some don’t. If you have the possibility of benefiting from a matching contribution from your new employer there is absolutely no good reason for NOT doing so. That is free money coming your way. Whatever your company will match as far your contribution up to the limit you should ALWAYS contribute to the maximum your employer will match. You would be shocked at the amount of people that forgo this free money. You will however have to make new investment choices. We can help you with that.

If you transfer to a self directed traditional IRA, assuming you are comfortable managing your own retirement account and assuming your employer does not offer a matching contribution, this is always your best choice. You are in charge of your investment choices, fees…, it really offers the most control and freedom in directing your retirement account. We can help you with this too.

A balanced solution would be to fund your 401K up to the maximum matching contribution from your employer and direct any other retirement dollars to an IRA.

If you transfer to a ROTH IRA it gets a little more complicated. Contributions to your 401K are funded with pre tax dollars while a ROTH IRA is funded with after tax money. Therefore in order to transfer your money to a ROTH IRA you will have to pay the taxes on the transferred funds.

There is also a new option called a ROTH 401K where your contributions are after taxes and your employer’s contributions are pre tax. This one gets a bit complicated and is beyond the scope of this article to discuss all the options available with this plan.

If you chose to take a lump sum distribution from your retirement account upon a job change or even at retirement you will have to pay taxes on the distribution (and a 10% early withdrawal penalty will apply if you are younger than 59 ½). Accepting a lump sum distribution upon a job change is normally a horrible financial decision. And yet you would be astonished at how many people chose this option. The excuses for doing so are endless: pay off credit card debt, buy a new vehicle, vacations… While there are isolated incidents where taking the lump sum distribution might make sense, that would only be on a case by case basis and can only be viewed as a risky financial decision.

If you transfer to an IRA you had better have a plan in mind for how to invest your money. Getting investing advice from your coworker / neighbor / relative… is usually a recipe for disaster. We will show you exactly what we are doing in our own retirement accounts before we even do it.