I mentioned Charlie Munger and his principle of inversion in a recent book review. Sometimes the best solution to a problem comes by approaching it backwards. You can learn more about it by reading the transcript from Mungers’ 2007 USC Law School Commencement speech. An excerpt:
Let me use a little inversion now. What will really fail in life? What do you want to avoid? Such an easy answer: sloth and unreliability. If you’re unreliable it doesn’t matter what your virtues are. Doing what you have faithfully engaged to do should be an automatic part of your conduct. You want to avoid sloth and unreliability.
What can you do to never retire? The broad answer is to never put anything aside for later. A specific answer is to cash out your retirement plan whenever you get the opportunity (i.e. when you leave a job).
Seems simple, right? But according to 401k behemoth Fidelity Investments, more than one third of all participants (35%) cashed out their 401(k) balances when leaving their job in 2013 (source). Among workers aged 20 to 39, a whopping 41% cashed out their 401(k) balances!
Cashing out before age 59.5 means you owe income taxes on the entire withdrawal amount immediately plus an additional 10% penalty. You only get allotted a certain amount of contributions to a tax-advantaged account each year, so that’s even more potential money washed down the drain.
I repeat, the most important thing to do is not cash out your 401(k). What you actually do with it instead is also worth some discussion:
- Roll it over into an IRA. I would say for most people, it is best to roll it over to an IRA at your own custodian. Brokerages like Vanguard, Fidelity, TD Ameritrade, and Schwab all have IRAs that feature low-cost ETFs and numerous other options (Barron’s broker rankings). They all want your money desperately, so if you have any problems at all, just call them up and ask for some help. My mom recently moved her 401k into a IRA at Vanguard and the Vanguard phone rep helped her through everything step-by-step.
- Keep it at your old employer. This may or may not be an option, but if you have a decent plan you could just leave it there for a while. Leaving assets in a 401(k) may allow you do contribute to a “Backdoor” Roth IRA for those people with high incomes.
- Move it to your new employer. It is harder to think of a compelling reason to do this these days. It used to be that some plans offered cheap institutional shares but now most ETFs already offer rock-bottom expense ratio. But again, you may want your assets to stay in a 401(k) and not an IRA for Pre-Tax IRA to Roth IRA conversion purposes.