After being laid off, I'm no longer funding my 401(k). I'm concerned it will dwindle away. What should I do?

QUESTION: I was laid off in April and have decided to stay at home with my children, so I'm not contributing to my 401(k) anymore. Its value is only about $20,000 — maybe less now — and I'm concerned that it will completely dwindle away. What do you recommend? Should I take it all out, put it into a mutual fund and pay the penalties, or just shift my investments? I have an international stock fund and two U.S. large-cap funds.

— Kate McGuire-Ilstrup


ANSWER: First off, your balance isn't going to fall to zero. "Without the entire U.S. stock market going completely flat, it can't happen," says Peter Di Teresa, senior analyst at fund-tracking firm Morningstar. But given the market's uncertainty these days, you should be psychologically prepared for your balance to fall even further in the short term. Over the long term, however, you can reasonably expect that your returns will eventually re-enter positive territory and your assets will continue to grow.

As we've written previously, during these tough times it's important that long-term investors such as yourself continue to hold the course in a 401(k). So as tempting as it may be to move your investments to more conservative vehicles, we strongly suggest that you stay put. Granted, at some point, you should review your asset allocation and, if appropriate, make adjustments. (That's really something you should do every year.) But switching your investments now would simply lock in your current losses.

Since you are no longer working for your former employer, you should eventually decide whether you want to leave your assets in your company-sponsored 401(k) or roll them into an IRA. Because you have more than $5,000 in the account, you can probably remain in the plan, although without the benefits of making additional contributions or borrowing against your balance. While it usually makes more sense to roll over the account into an IRA (for reasons we'll discuss below), some people do choose to stay put, particularly if they are happy with the plan's fund selection, says Di Teresa.

Even if you aren't thrilled with your current investment options, it probably isn't a bad idea to hang tight in your 401(k) for the near term, at least until "life is more normal again — when we're traveling, we're buying, we're going to theaters," says certified financial planner Bob FitzSimmons, based in Lincoln, Neb. That's because whenever you leave your 401(k), your shares will be cashed out before they are rolled over into your IRA. In such a volatile market, you run the risk of selling low and buying shares at a higher price.

Once you're confident enough to shift your assets, rolling them over into an IRA is probably a wise move, since you'll then be able to choose from every mutual-fund company that offers IRA accounts, not just those in your plan. Also, there are several ways to access the funds in your IRA for things like education expenses and nonreimbursed medical costs. (Not that we recommend doing so unless it's an emergency.)

Rolling over your account to an IRA may also give you the option of converting your account to a Roth IRA, which over the long haul gives you more bang for your buck since withdrawals taken during retirement are tax-free. (With a traditional IRA, withdrawals are taxed as ordinary income.) Under current guidelines, singles or couples are eligible to convert a traditional IRA to a Roth IRA if their adjusted gross income is $100,000 or less. When you convert a traditional IRA to a Roth, however, you'll have to pay taxes on the account upfront, so just make sure to have enough money on hand to handle that without cashing in any of the IRA, stresses CFP Dee Lee of Harvard, Mass.

What you should avoid at all costs is cashing out of your plan and investing it in a taxable fund account. Why's that? Because you'll owe taxes on the account (which could run as high as 39.1%) and if you're under age 59 1/2, you'll be socked with a 10% early-withdrawal penalty to boot. If you think your balance looks decimated now, just think of how bad it will look after that.