This is a guest post from Todd at The Working Dollar.
When you leave your job, you have several choices regarding your 401(k). These options are pretty much universal, meaning they apply to every 401(k) and to every job change situation. Your options are:
Cash the 401(k) plan and receive a full pay-out
I’ve listed this option first because it has the most serious ramifications.
First, if you take a full payout, you will have to pay taxes on the plan — usually 20% off the top when you take the money out, and a 10% penalty when you file your taxes if you are below the age of 59-1/2.
Second, if you have no other retirement plan and you take a pay-out on your 401(k), then you now have no more retirement money. You must start again from the beginning, and this puts you behind.
If you take a full payout but then decide you shouldn’t have done so, there’s still hope. The IRS has provided the 60-day rollover rule, which allows you take the money you withdrew from your 401(k) and roll it into an IRA within 60 days. You still pay taxes at the time you take the money out of the 401(k), so it’s your responsibility to find the cash to bring the IRA contribution to the level of your 401(k) withdrawal. However, when you file your tax return, you get a credit for the taxes on the 401(k) and for the 10% penalty. (Documentation is required.)
Roll the money to a new 401(k) plan
This option generally has no negative ramifications. Simply take the money from your old 401(k) plan and move it to the 401(k) plan at your new job. The money moves from one account to the other. There are no taxes or penalties involved. Best of all, you keep all your retirement money and can now add to it in the new 401(k) plan.
However, if there is a waiting period until you can participate in your new employer’s 401(k) plan, be sure you can let your money sit in the old 401(k) for the required time frame. If you’re not allowed to do this, all is not lost. You have another option.
Roll the money to an IRA
This option also usually has no negative ramifications. You can always take the money from your old 401(k) and roll it into an IRA. The transfer will occur without incurring taxes or penalties. Moreover, once the money moves into the IRA, you can continue to contribute to the IRA at your discretion. You’ll have more investment choices available, and the IRA will have fewer restrictions than your 401(k) plan.
You can also roll your 401(k) money into a Roth IRA, but you need to remember that a 401(k) plan is a pre-tax plan, and a Roth IRA is an after-tax plan. You will need to pay taxes if you move from a 401(k) to a Roth IRA, unless you are rolling after-tax money. Be sure to ask your 401(k) representative about this option for further details.
Leave the money in the 401(k) plan
This option has a few ramifications, but they aren’t serious. If you meet the minimum amount required to keep the money in your existing 401(k), then you can leave the money alone, perhaps giving you time to decide you decide what to do with it. Be sure you to find out what the minimum required amount is for your particular 401(k) plan. These minimums can range from $1000 to $5000. (Each plan is different.)
If you decide to leave the money in your existing 401(k), there are several things to consider. First, you will not be able to make additional contributions to the plan. Remember, a 401(k) is a payroll deducted plan; if you leave your job, there is no payroll from which to contribute. Second, you must keep tabs on the 401(k). The plan can change hands from one record keeper to another, and the onus is on you to track where the plan moves if this happens. Third, you typically cannot roll into a 401(k) plan if you are no longer working for the company. However, you will want to check the rules to see if this rule applies to your plan.
These are the choices for your 401(k) plan once you leave your current job. Be sure to research the options that apply to your situation. Remember that you are making a decision that will affect your retirement savings, affecting how much money you may have when you retire. Getting the facts will make this transition easier for you.
Note: If you’re faced with this situation, be sure to read the comments on this entry for additional discussion on the nuances involved.
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