Whether you're switching jobs or retiring completely, chances are you have a 401K or other company sponsored retirement plan that you?ll need to make a decision about.
There are several options on how to handle your 401(k) money when you leave a job:
Take the Money and run: This is probably the most tempting, but also the most costly, of all the options. This is almost never a good idea because of the tax consequences. For starters, your employer is required to withhold 20% of your distribution for tax purposes, so the amount you will receive may be significantly less than you expected. Second, if you're under age 59 1/2, you'll generally have to pay a 10% early distribution penalty in addition to regular income tax on the entire amount withdrawn. In addition to the tax bite, you will also miss out on the tax-deferred growth of a 401(k) or IRA account.
Leave the money in the 401(k) plan: Another option is simply to leave the money in your former employer's plan. This will allow the funds to continue to grow tax-deferred. If you are happy with the investment options available in your former employer's plan, or if you are not eligible to participate in your new employer's plan, this may be a good alternative.
Transfer the funds directly to your new employer's retirement plan: Many employers allow you to roll your 401(k) funds from previous employers into your new employer's retirement plan. This may be a beneficial strategy if your new employer has a good selection of investments in the plan.
Transfer the funds directly to an IRA account: One of the main benefits of rolling your 401(k) into an IRA account is the investment choices. IRAs are typically held at brokerage or mutual fund companies, and therefore offer many more investment options than most employer provided retirement plans. IRAs also offer more flexibility when it comes to getting to your money.Although loans from your IRA are not allowed, you can take distributions for a variety of reasons (new home purchase, education costs, unreimbursed medical expenses) without paying the 10% premature distribution penalty. The best way to transfer funds to your IRA account is to have your employer's 401(k) plan administrator transfer the funds directly to your IRA account. This is a direct rollover.
Have the check made out to you, and then deposit the funds into an IRA account: You can also do an indirect rollover to your IRA. If your former employer sends the distribution check directly to you, you can still deposit the funds into an IRA account. This is known as an indirect rollover. There are two disadvantages to this approach. The first is that your employer is required to withhold 20% for federal income taxes.Unless you make up this 20% with out-of-pocket funds, when you roll your funds into an IRA account, the 20% withheld will be subject to regular income tax and the 10% early distribution penalty, assuming you're under age 59 1/2. The second disadvantage is that you only have 60 days from the date your employer sends you your funds to roll that money into an IRA account. If you don't make your rollover deposit within 60 days the entire amount will be subject to regular income taxes and a 10% early distribution penalty.
For more help on 401(k) options when you leave a job, consult your tax professional or a fee-only financial planner.