If you’re getting ready to leave a job, you might be considering cashing out your 401(k) retirement plan. But in addition to losing the financial safety net your 401(k) plan offers, depending on your age, you’ll likely have to pay a penalty for early withdrawal in addition to paying income tax on the money you receive from cashing out. To avoid these outcomes, it’s important to know what other options are available to you, including not rolling your money out.
Moving your money to your next job
If you’re leaving your current job for another company, check and see if the new company offers a 401(k) plan and that they accept rollovers. If they do, the administrator at your old company can help you move the money to the new employer’s 401(k) plan once you enroll. There are two different ways you can do this. You can either do a direct rollover or an indirect rollover.
The first option and the simpler of the two types of rollovers is what’s known as a direct rollover. Typically, with direct rollover, you can simply contact the 401(k) provider at your new company and let them know. They can help you complete a request to roll over your funds. Your new 401(k) provider will likely oversee the entire process once you’ve put in your request. You typically won’t have to take further action — and you won’t have any taxes or penalties to deal with.
Your second option for moving your money is what’s known as an indirect rollover. Your past employer sends you a check for the full account balance in your 401(K), and you can then put it into your new company’s 401(k) plan.
One negative aspect of this type of rollover is that it can cost you money. The reason behind this is that it’s considered cashing in a plan early. It will come with a mandatory federal tax withholding of 20%. After receiving your funds, you have a 60-day window to invest them in another 401 (k) plan, or you may be penalized with an additional 10% in some circumstances if you’re under age 59 ½.
If you deposit the gross amount of your rollover check — what you’re paid plus the 20% federal income tax that was withheld — there is no cost to you aside from the prepayment of taxes. To defer tax on the taxable portion of your indirect rollover, you need to add these funds from another source to make up for the 20% that was withheld.
Now that you’re aware of what to do with your 401(k) if you’re moving your funds into a new plan, here’s what you do when you aren’t going to be moving into another plan.
What to do if you aren’t moving to a new 401(k) plan
If you’ve decided not to roll your money over into a new 401(k) plan, you may want to consider some other investment options.
Roll Your Money Over into an IRA
You could roll your money into an individual retirement plan, or IRA. By doing this, it will allow you to continue growing your tax-deferred contributions. But there are a few important things to know about your 401(k) rollover to avoid making costly mistakes.
If you consider opening an IRA, there are two options available to you; Roth IRA or Traditional IRA. If you choose a Roth IRA, you have to pay taxes on the amount you rollover from your 401(k). If you opt for a traditional IRA, however, you won’t have to pay any taxes up front when you do a direct rollover.
Get help from a financial advisor
A financial advisor can help you decide which option is best for you, they can help you open up a new account, and set up the rollover of your 401(k). When you’re ready to make the most of your 401(k), you can also search for the best plan for your needs.