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The Basic Options Available for a 401K Rollover
With the way the economy is today there is a good chance that in your working lifetime, you are going to work for more than one company. The days of staying with the same company for life are long gone. If you have a 401K retirement account with the company you are working for and change companies you will need to follow the 401K rollover rules very closely to ensure that you do not end up paying taxes and penalties for early withdrawal on the money you have been putting away for retirement.
Penalties for Not Taking a 401K Rollover
When you leave a job where you have been contributing to a 401K retirement account you have the option to simply cash out your retirement account and keep the money. However, you should know that this choice does not come without some relatively high penalties if you are under age 59 1/2. To start with the IRS is going to assess a ten percent excise tax on the money.
Then because the money was taken out of your paycheck pre-tax or before it was included in your taxable income, you are going to have to pay income taxes on it. These taxes will be assessed for the tax year in which you cashed out your 401K. Depending on how much your account had in it, this could be a significant amount of money you will end up owing the IRS at the end of the year.
Avoiding Taxes and Penalties with a 401K Rollover
If you are changing jobs, you will want to take your 401K account with you to your new employer or roll it over into another form of tax deferred retirement account. In most cases people rollover their 401K to an IRA as this gives them full control of their retirement account and as long as the rollover is completed within 60 days of closing out their 401K account the IRS will not assess any penalties and you will not have to pay any taxes on the money.
The options you have when you want to perform a 401K rollover are relatively simple as stated; you can simply take your 401K with you to your new employer when you change jobs, as this avoids all penalties and fees. If your employer is changing asset management firms, you can let them move your account to the new firm at no cost and with no penalties.
You can go to an investment firm of your choice and establish an IRA account, cash out your 401k and roll it over into your new IRA. As long as you complete this 401K rollover within 60 days of cashing out, you will pay no penalties or fees, unless your employer has any early withdrawal penalties. If you fail to open a new IRA within the 60 day window, you will be assessed a 20% penalty by the IRS. This is a substantial amount of money to risk losing, so it would benefit you to have your IRA up and running before cashing out if possible.
The 401K Rollover and a Roth IRA
You can also roll your 401K into a Roth IRA, however, if you choose this option you will have to pay taxes on any money that you are taking out of your 401K because the Roth IRA was designed as an after tax retirement account unlike the 401K which is a pretax retirement account. If you are thinking about starting a Roth IRA you need to check with a financial advisor to make sure you meet the eligibility requirements. If you are not sure, you can put your money in a traditional IRA and roll it over into a Roth at a later date with no penalties. The most important thing to remember with a Roth IRA is that you are going to have to pay income taxes on the money you put into your Roth IRA.
Most of us use a 401K rollover plan to protect the money we have been saving for retirement when we change jobs or the company we are working for goes out of business. Study your options very carefully and choose wisely so that you end up with the maximum amount of money for your retirement years.