Things You Didn’t Know About Rolling Over A 401k

By Matthew Cenzon. May 7th 2016

One of the many benefits that most companies offer is a 401k plan for your retirement. However, if you ever leave the company, whether it's on your own terms or not, you must decide what you wish to do with your 401k assets. If you are under the age of 59 1/2, you may suffer a penalty from withdrawing from your 401k too early. Taking a cash distribution of your 401k also means you are losing the opportunity to grow your investments on a tax deferred basis and that state and local taxes may apply to any money you receive. To avoid penalties and to continue to allow their retirement assets to remain tax deferred, many people consider rolling over their 401k plan to a new employer's plan or into an IRA.

Rolling Over Into a New Employer's 401k Plan

Once you start working for a new employer that has a 401k plan as part of your company benefits, make sure to ask whether they accept rollovers from a previous employer's plan. If they do, you can transfer the funds directly from your previous 401k plan to your new one. This will allow your retirement assets to continue to grow without suffering any income taxes or a 20 percent withholding tax.

If your previous employer made any matching or profit sharing contributions to your 401k plan, make sure you determine what percentage of these earnings you are allowed to keep. While you are usually 100 percent vested in contributions made directly from your paycheck, any rollover funds from previous plans and any earnings thereon, your years of service with the company may be used to calculate what percentage of the employer's contributions you are entitled to.

Rolling Over a 401k Into an IRA

An IRA, or Individual Retirement Account, is a savings account that benefits from similar tax breaks as a 401k plan. IRAs are recommended for those who do not have the benefit of a company sponsored 401k plan, like self-employed individuals or contract workers. If your new employer does not allow rollovers from previous 401k plans, an IRA would be your next option. Many financial advisors will inform you that the greatest advantage to an IRA over a 401k is a wide array of investment choices.

If you are eligible (if your annual income falls under a certain amount), consider rolling over your previous 401k into a Roth IRA, and starting a new 401k with your new employer. While you may no longer be eligible for tax deductions on a traditional IRA if you also have a 401k, a Roth 401k has its own advantages, like less withdrawal restrictions or requirements. Having both a Roth IRA and a 401k would allow you to receive matching contributions from your employer's 401k plan, tax diversity and the benefit of more investment options from a Roth IRA.

More Things You Need to Know About Rolling Over a 401k

  • If you accepted a cash distribution from your previous employer's 401k plan in a lump-sum, and suffered the mandatory 20 percent withholding, you can still recover the money lost. To do this, you would need to invest your cash distribution into an IRA, plus 20 percent of your own money to cover the amount that was withheld. This will allow you to receive credit for the money that was originally withheld when you file your income tax return.
  • You don't necessarily have to rollover your 401k plan when leaving an employer. You may still be able to keep the money in your former employer's plan, allowing your assets to remain tax deferred. However, not all employers offer this option, and certain rules and restrictions may apply.
  • Determine the fees for rolling over a 401k into an IRA. In some cases, it may be a wiser strategy to go with your new employer's 401k rather than a high-priced IRA.
  • To avoid the hassle of transfer penalties and the 20 percent withholding, make sure your previous employer transfers the money directly to an IRA or your new 401k plan rather than giving you the money directly.
  • Some employers require you to be employed for a certain period of time before offering the benefits of a 401k plan. If 401k eligibility were to require at least one year of employment, you may want to consider rolling over your previous 401k into an IRA instead.

Bottom Line

In the end, you may want to strongly consider rolling over your 401k from a previous employer into an IRA account. The largest benefit of an IRA account is how you can invest your money. With an IRA, you typically have more control and more investment choices than a 401k account. Whether you wish to rollover into a new employer's 401k plan, or an IRA, just know that you have options for your previous 401k aside from withdrawing the money and suffering any penalties.

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