Prev: My company is going out of business. What happens to my retirement savings account?
You have several options for taking your 401(k) with you, but be aware of the tax consequences. Time your departure to your advantage, if you can. When you leave your company, you’ll need to do some paperwork – and that includes making a decision about what to do with your 401(k) account. Here are your options:
If you leave a job, you have the right to move the money from your 401k account to an IRA without paying any income taxes on it. This is called a “rollover IRA.”
If you decide to roll over your money to an IRA, you can use any financial institution you choose; you are not required to keep the money with the company that was holding your 401(k).
Ask the mutual fund company, bank or brokerage that will manage your IRA for an IRA application. Make sure your former employer does a “direct rollover,” meaning that they write a check directly to the company handling your IRA. If they write the check to you, they will have to withhold 20% in taxes.
You won’t be able to make contributions anymore, but this is an option. This is acceptable as a temporary solution while you look for a new job or research where to open your rollover IRA. But it’s not recommended for the long term, because the company may change their investment options over time, and it won’t be easy to ask questions or make changes if you’re no longer working there. If your account balance is less than $5,000, the company may not allow you to leave your money in their plan at all.
Cash out. WARNING! If you take a “lump-sum distribution” instead of rolling your retirement savings account over to an IRA or a new employer’s plan, you will have to pay income taxes on the money. You will also pay a 10% early withdrawal penalty if you’re under age 59 ½. Not only do you lose money, but you lose valuable time in building savings, and may never catch up.
Timing is important here. If your company offers matching contributions, don’t walk away and leave that money on the table. Check your plan’s vesting schedule to see whether working longer will let you vest more in your employer contributions. Also, find out when matching contributions are deposited into your account. Some companies make the deposit every pay period; some only once a year. If you leave before that year’s contribution is made, you’ll lose it.
* This hypothetical example assumes the following: (1) One annual $5,500 IRA contribution made on January 1 of the first year, (2) annual rate of return of 7%, and (3), no taxes on any earnings within the IRA. The ending values do not reflect taxes, fees or inflation. If they did, amounts would be lower. Earnings and pretax (deductible) contributions from a traditional IRA are subject to taxes when withdrawn. Earnings distributed from Roth IRAs are income tax free provided certain requirements are met. IRA distributions before age 50-1/2 may also be subject to a 10% penalty. Systematic investing does not ensure a profit and does not protect against loss in a declining market. Consider your current and anticipated investment horizon when making an investment decision, as the illustration may not reflect this. The assumed rate of return used in this example is not guaranteed. Investments that have potential for a 7% annual rate of return also come with risk of loss.
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