6 smart 401(k) moves for rough times

Escape a 401(k) the right way

DUMB: Shunning the 401(k) plan because you're afraid of Wall Street "tricks." If you have an employer match, you're being paid to learn how to avoid them. "If your bank was offering you a dollar for every dollar you contributed, would you think that was a good deal? Of course you would. Yet some people think the 401(k) match is different," says Peter A. North, a planner in Orange Park, Fla.

If you're a novice, look for a fund option that owns both stocks and bonds, like a balanced or target-retirement fund. Own it while you're learning the ropes.

SMART: Getting out of a 401(k) when you leave the company. You can roll it into a self-directed IRA with unlimited investment options at a discount broker. And even good 401(k) plans can have bad rules.

Carolyn T. Walder, president of Lifetime Wealth Planning and Management of Alexandria, Va., says her clients have included beneficiaries of plans that automatically cash out plans upon death and withhold 20% of the proceeds for federal tax (the federal Thrift Savings Plan, notably).

"Get out when you can," she warns. "The beneficiary has no say in how or when they get to take the money out, and this can have a tremendous impact on their tax planning." Self-directed rollover IRAs can be inherited without a huge, immediate tax bill.

Don't owe money -- even to yourself

DUMB: Borrowing from your 401(k) because "you're paying interest to yourself." Don Martin, president of Mayflower Capital in Los Altos, Calif., notes that you'll pay taxes on that interest, "yet no deduction is allowed for interest expense." Also, if you change jobs or get laid off, the whole loan could come due on the spot.

SMART: Pay back any loan as fast as you can, because you'll earn far more on the stocks you can buy cheaply now than on those "interest" payments.

Sell company stock the right way

DUMB: Selling highly appreciated company stock if you're near retirement. "The tax break on net unrealized appreciation will be lost forever," warns Jeremy E. Portnoff, a financial adviser in Westfield, N.J.

This little-known tax dodge works like this: The IRS will allow you to withdraw company stock in-kind (that is, you don't have to sell it first) from a 401(k) or other deferred-compensation plan at retirement and deposit it directly into a brokerage account. The tax "basis" in the stock becomes the value when it is transferred, not when it was originally purchased, when it was presumably worth much less.

Proceeds from retirement accounts are taxed like ordinary income, at rates approaching 40%. With this move, you pay the capital gains rate of 15% or less.

SMART: Selling excess company stock, such as the sort used for the annual match, as soon as you can. Since your income is already tied up in your job, tying your nest egg to the company as well exposes you to extra risk, says Lauren G. Lindsay of Personal Financial Advisors in Covington, La.

"Make sure it's not a substantial chunk of your overall portfolio," she says. "Most advisors like to keep it below 20%, or even 10%."

You don't need a perfect investment portfolio to retire well. But you do need a portfolio. Today's 401(k) plans are loaded with incentives. Take advantage of them. Don't look back from the future in sorrow.

Meet Tim Middleton at The Money Show

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At the time of publication, Tim Middleton owned the following securities mentioned in this article: SPDR Lehman International Treasury ETF.

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