Jobless? What to do with your 401(k)

By Jeff Schnepper

Remember the good old days when the big R-word was "rebate" rather than "recession"?

That was before your 401(k) retirement plan melted down to a 201(k). That was also before your company was downsized and you lost your job -- or before you jumped ship to a company that didn't view the movie "Titanic" as a business plan.

In either case, you still have those 401(k) dollars with your old employer. What should you do with that money? Here are your five options:

Cash out

Rule No. 1 in retirement planning: Never touch your qualified money until you actually retire. Rule No. 2: The first rule doesn't count if your family is hungry.

If you need the money to live, take it. Your retirement savings fund will go down, and the distributions will be added to your income, to be taxed at your highest marginal rate. If you're under age 55, the Internal Revenue Service will hit you with a 10% premature-distribution penalty. You'll also lose all the future tax-deferred growth on your investment. And your old employer will withhold 20% of the distribution for federal tax payments.

At least the IRS doesn't take your firstborn child, although the vote in Congress was close.

If you are still with your company, consider a loan from your 401(k) rather than taking the money outright. You're paying interest, but it's to your own account, and there's no immediate tax or penalty. The danger is that if you leave the company (voluntarily or not), most plans require immediate payback of all outstanding loans.

The bottom line here is to make this your last choice for a source of funds. But if you need the money to live, you really don't have any other options. Withdraw only what you need, as you need it.

Leave the money where it is

Leaving your 401(k) in your former employer's plan, if the option is offered, allows your money to continue growing tax-deferred. It protects those assets from any attacks by creditors. You can make early withdrawals without penalty if you retire, quit or are fired at age 55 or after. You still have the option of borrowing funds from the account if necessary. There's no tax penalty for leaving the money alone. And you can always transfer the funds to another employer's 401(k) once you get a new job.

The downsides are potentially high fees and limited investment choices. But if you don't need the money immediately and you like the plan's investment options, this may be the way to go.

• Jeff Schnepper on video: Lost your job? Here's a tax tip

Just don't do it too often. If you have multiple accounts with former employers, things can get messy when you reach retirement age. Taking the appropriate minimum distributions may become convoluted and difficult. (Miss a required distribution and you owe a 50% penalty on the amount you failed to take.) Depending on the wording of the plan, your heirs may not be able to stretch out distributions. In this case, you'll want to consider the following.

Make a rollover to a traditional IRA

Wide investment choices and potentially lower fees make this an attractive option. The money isn't taxed when you move it. You continue to get tax-deferred growth. If you don't contribute any additional money to the account, you retain the option of transferring it to another employer's 401(k) plan in the future.

This option is attractive if you want more investment flexibility or want to consolidate multiple accounts. It's easier to monitor and manage a single account, and it simplifies required minimum distributions. Also, your heirs can take individual retirement account distributions over their lifetimes.

On the downside, you can't borrow against an IRA, and you normally have to wait until age 59 1/2 to take distributions without penalty.

Continued: Consider a Roth IRA

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