When you leave your job, whether its voluntary or not, you’ll have to make some important decisions about what to do with your 401(k). Should you roll it over? Get an IRA? Leave it alone? Cash it out? Antwone Harris, a certified financial planner with Charles Schwab in Washington, D.C., says there are four options.
Option 1: Roll the money into your new employers plan
If your new employer accepts your previous employer’s 401(k) plan you can simply roll it over. There are no taxes or penalties to do so and the money continues to grow tax deferred.
Myth Buster: Your new employer and previous employer do not have to do business with the same brokerage firm in order to accept the rollover.
Option 2: Leave the money with your previous employer
“The only reason you would want to do this is if you have a loan against your 401(k),” explains Harris. In general, you’ll have to repay that loan in full before you make any movement. Also, if you leave the money with your old employer’s plan you won’t be able to add any more money to it and you’ll also have less investment options than you would with an IRA, which has thousands of mutual funds to choose from.
Quick tip: Make sure there are no administrative fees and the 401(k) bylaws are the same for non-employees.
Option 3: Roll the money into an IRA
IRA’s offer the same tax advantages in addition to more investment options. You can invest in mutual funds, individual stocks, bonds and real estate.
Here’s how you do it:
- Open an IRA with the trusted brokerage firm of your choice.
- Call your human resources department at your former job and request a direct rollover form (generally 1-5 pages).
- Put your new account number on the form and make sure to select direct rollover (not distribution).
- Confirm with your HR department that they will mail out a check to you. You have 60 days to deposit the funds into your new IRA account.
Quick Tip: Some brokerage firms offer specialized roll over agents to assist you in the process. Please also note that since 401(k) contributions are made before taxes are taken out, you cannot roll your money directly into a Roth IRA, which allows tax free withdraws.
Option 4: Cash it out
This option is listed last because it’s one that you want to avoid if possible. It has the most serious ramifications if you are under age 59 ½. Receiving a full payout will cause you to pay taxes on the money (usually 20% off the top) and you will be subject to a 10% penalty as well.
Saving Grace: The IRS has a 60-days roll over rule that allows you to take the money you pulled out and roll it over into an IRA. Please note you will have to pay a mandatory 20% withholding fee, but you can recoup the money when you file your tax return (20% tax credit).