401k retirement plans have never been more challenging to figure out — and we’re not talking just about the stock market’s volatility. Today’s economy confronts us with the stiffest financial and career challenges in decades. That translates to some very complicated situations for retirement investors.

If you are changing jobs for any reason, but especially if you have been laid off, you are faced with a financial decision no less important than your career choices. Keeping on top of your retirement funds may seem like a fighting a losing battle with all the information out there about Roth IRA conversion, individual retirement accounts and other 401k investing issues. But the choices you make now will have effects that matter deeply down the road.

Perhaps the most relevant question for many now is, “What should you do with your 401k retirement savings from your previous employer?”

401k Retirement Plans and Job Changes

There are a number of options including keeping the money in your existing plan, folding it in to your new employer’s 401k, or rolling the account over to an IRA. The latter is the best choice for most investors.

Your worst move is to take a lump sum distribution – that is, to cash out. Such an early withdrawal may be unavoidable for those who really need the money now, but it will devastate the potential future value of your retirement savings.

Of course, these are general rules. Based on your specific 401k or your financial needs, you may find that your unique situation dictates a different move. To help you make the right choice, here are your 401k options available after a job change.

Cash distribution: We all want a lump sum of money dropped in our laps, but when we pull our money prematurely out of a tax-deferred plan, somebody else gets a lump sum too – the IRS. The money you take out of a 401k before age 59.5 will be taxed as ordinary income and be subject to 20% tax withholding and a 10% early withdrawal penalty.  Many mutual fund companies have online calculators to demonstrate just how much damage you will do to your future wealth by taking an early cash distribution. The difference can be thousands of dollars, particularly for younger workers who would be forfeiting decades of tax-deferred compound returns. Even if you plan to take an early distribution, it’s probably better to do an IRA rollover first. For one thing, most plans do not allow you to make a partial cash withdrawal from a 401k when you no longer work at the company. You also have more flexibility on tax withholding and in certain cases could qualify for an exemption from the 10% early withdrawal penalty when taking a distribution from an IRA.

Do nothing: This can be a valid option, particularly if you have good investment choices in your existing 401k. There’s no hurry to move. But does your 401k really have better variety than a large mutual fund company with a hundred or more fund choices? Do the funds available through your previous employer really have the best ratings and track-records you can find? In addition, staying put limits your control over your money. Most 401ks have more restrictions on investment moves than IRAs, and customer service is more limited. Also worth noting is that if your 401k is worth less than $5,000, your employer may automatically roll it over to an IRA with the firm that acts as the 401k custodian, which might not be the custodian you would have chosen. Most plans also impose administrative fees on former employees. For those investors still caught in the headlights of the recent bear market and afraid to make any investment move, doing nothing is certainly the easy choice — but usually is not the best choice.

IRA rollover: Rolling your 401k over to an IRA is the best move for most former employees. A rollover maintains the tax-deferred status of your retirement funds and avoids early withdrawal fees. If you have had several employers, rolling all of your 401ks to a single IRA account can greatly simplify your record-keeping. A rollover also gives you maximum control over your money and, typically, greater investment choices, with investment options including mutual funds or individual stocks or exchange-traded funds (if you open an IRA brokerage account). Rolling your account over also enables you to make partial withdrawals to meet immediate financial needs. Unlike withdrawals from 401ks, IRA distributions can be taken without any tax withholding (you’ll just have to settle with Uncle Sam at tax time). In some cases, such as when buying a first home, paying tuition or certain medical expenses, investors can avoid the 10% early withdrawal fee, but only from an IRA, not a 401k. An IRA rollover also enables you to continue making contributions to your account rather than waiting to be eligible for a new company’s retirement plan. The large mutual fund firms provide ample information to help you make a choice, and make the rollover as easy for you as they can (in order to get your business, naturally).

• Mutual funds: The best asset-management companies offer a wide array of quality funds with low expenses and good customer service. If you find the range of choices intimidating, these fund families offer tips and advice on appropriate funds to consider, asset allocation and risk tolerance. Many offer so-called “retirement funds” that handle the asset allocation for you, gradually adjusting your investment mix as you get older.
• Brokerage: This is the ultimate in investment freedom. You can roll over a 401k with few options to an account with thousands of stocks (as well as funds) at your fingertips. Beware of brokerage firms that charge inactivity fees for those who do not trade often enough. Discount brokers offer rock-bottom commissions on stocks and often provide access to mutual funds from a variety of companies as well. Discount brokers associated with large mutual fund companies such as Fidelity, Vanguard, or T. Rowe Price also offer free access to the company’s funds as well as those from select other managers without a transaction fee.

Rollover to new company’s 401k: This is advisable only in rare cases where your new employer’s 401k offers a tremendous array of choices, or you prefer to keep just account rather than having a 401k and an IRA. The option also allows you to continue making new investments even before you are eligible to contribute to your new company’s plan, though you also can do that with a rollover.

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