Pair Your 401(k) With a Roth IRA

While it's hard to beat the company match on a 401(k), this shouldn't be your only retirement account. If you're eligible to invest in a Roth IRA, it's a perfect companion to a plan with a match.

If you're single and have adjusted gross income (AGI) under $110,000, or you're married and file a joint return with AGI below $160,000, you're eligible to invest in a Roth. The maximum contribution is $4,000 this year, or $5,000 if you're at least 50 years old.

While you won't get any tax break on the money you invest in a Roth, the contribution grows tax-free, and assuming you follow some simple rules, all of the money will be tax-free when you retire and withdraw it. That's a lot different if you make withdrawals from your 401(k): Every penny will be taxed at your regular income tax rate -- you don't even get to take advantage of the typically lower long-term capital-gains rates.

So if you can Roth, do it! Ideally you can fund a 401(k) to the max as well as invest in a Roth. But if that's too much of a financial challenge right now, use this strategy: If your employer offers a matching contribution to your 401(k), make sure you invest just enough in the plan to qualify for the maximum match, but not a penny more. That should leave you with some extra money to fund the Roth.

And if your employer doesn't even offer a 401(k) match, I would actually make the Roth the first priority. Once you get the Roth funded, you can go back and contribute to your company 401(k).

Sell Your Company Stock

The merits of diversification -- spreading investments prudently among different stocks, bonds, and funds -- are widely understood. But another scary habit reported by the Hewitt folks is that among 401(k) participants who have access to company stock in their plan, the average amount invested in such shares is an insane 25 percent. That's one-quarter of your future retirement riding on one investment, when study after study shows that diversification -- not letting any single stock account for more than 5 to 10 percent of your assets -- offers a far better risk/reward return.

Your company pulling an Enron isn't the only concern here. Your retirement portfolio can take a huge hit if your employer runs into any type of challenge: A lousy product launch, increased competition (domestic and global), an ill-conceived merger or acquisition, or a management change that pulls the company off course. It can happen to any company at any time.

Don't Take the Money and Run

When you leave a company -- because you retire or switch jobs -- you're no longer required to keep your money invested in your old employer's 401(k) plan. You have a bunch of options:

1. Keep the money invested in your old employer's plan. (This is allowed if you have at least $5,000 in assets.)
   
2. Move the money to your new employer's plan (not all plans allow this).
   
3. Cash out of the account.
   
4. Do a direct rollover from your old 401(k) into an IRA at a fund company or brokerage where you have complete control of what you invest in.

Options 1 and 2 can be O.K. if you're absolutely sure the investing options offered in the plans are the best you can get. But when you stick to an employer's plan, you're typically restricted to the small lineup of funds offered within that plan. If those aren't the best-performing low-cost funds, why stick around?

Option 3 is a ticket for retirement doom. But it seems that almost half of job switchers choose to take the money as cash rather than keep it invested for retirement. It's most tempting when there's "just" a few thousand dollars in the account, but that's actually a huge amount.

Let's say you're 25 years old and have $2,000 invested in your 401(k) when you decide to get a new job. If you cash out that $2,000, you'll pay income tax on it as well as a 10 percent early withdrawal penalty. If you're in the 25-percent tax bracket, that $2,000 just got shaved down to $1,500.

That seems like a big waste to me. Consider what $2,000 today can grow to by the time you're 65. Assuming the money compounds at an average annual rate of 8 percent, you'll have a nice egg in your retirement nest worth more than $43,000.

The far smarter move is Option 4: Do a 401(k) rollover where you move your money directly from your old 401(k) into an IRA at any fund company or discount brokerage. When you fill out the paperwork at the company, you'll be moving the money into -- it's a simple application and the firms are eager to help you -- make sure you opt for the "direct rollover" option. This means that your ex-employer will send your 401(k) money directly to the firm where you have set up your new IRA. The direct route ensures you sidestep a nasty IRS trap that can lead to a hefty tax bill.

Here's an example: Let's say you decide to rollover the $10,000 in your 401(k), but moving the funds directly from the 401(k) to your new IRA account, you tell your old employer to send you the money because you haven't decided where to open the new account. You've just entered the danger zone, my friend.

First, your ex-employer will automatically withhold 20 percent for tax. So your $10,000 is just $8,000. But according to IRS rules, you must invest a full $10,000 into an IRA to avoid any extra tax. So you'll need to come up with the other $2,000 out of your own pocket -- and fast. The rule is that you have to move that old 401(k) money in an IRA in just 60 days -- otherwise, you'll have to pay income tax on the entire amount and a 10 percent penalty if you're under 55 that year. (Yes, 55, not 59 1/2 -- I'll explain that twist in a minute.)

You can avoid all of this craziness if you simply instruct your IRA provider to work with your 401(k) plan to have the money moved through a direct rollover. You never touch the money so there's no chance of a tax bill.

Now about that 55 rule. If you're at least 55-years old when you leave your employer -- voluntarily or not -- there are different withdrawal rules. Typically, you'd be hit with a 10 percent early-withdrawal penalty if you took money out of your 401(k) before turning 59 1/2. But a quirk in the law says if you leave your company after turning 55 -- but before you're 59 1/2 -- you can withdraw money and not be hit with the 10 percent penalty.

While it's always best to leave the money untouched for as long as possible to take advantage of compounding growth, this quirk can be a big help if you're out of work earlier than you anticipate and have some cash-flow issues. You could withdraw whatever you need to live on without paying the penalty and then rollover the rest of the money into an IRA. But even though you'll be immune from the 10 percent early-withdrawal penalty, you'll still need to pay income tax on all your withdrawals. There's no way to get around that rule.

I like Suzy Orman. Watch her show on the regular basis.

Those are good advice. Now with the new Roth 401(K), we have one more option! Many readers may have come accross the differences between a Roth 401(K) or a traditional 401(K) plan (either from the previous posts in this forum, or elsewhere), but you may not be aware of the difference between a Roth IRA and Roth 401(K).

I will throw out some ideas for your reference on this subject.

If I remember right, I recall you mentioned you like Orman's articles.  I also sensed that someone will mention Roth 401k.

I would like to see your ideas throwing out.

Certain individuals here including Heavysnow have briefly introduced the basics about Roth 401(K). I am not going to revamp the wheels and restate the same or similar facts. I have, however, been planning on summarizing the situations (pre-requites) that we may choose Roth 401(K) or pair Roth 401(K) with existing traditional 401(K) to better achieve retirement saving goals.

班班，please advise if I should start another thread on this topic or just start a new one for the discussion convenience.