A 401k plan is a retirement plan that allows workers to make regular contributions to the plan from their pay. The money is taken out before federal taxes are determined, reducing tax liability. Often, the person's employer contributes an additional amount to the 401k. Normally the funds remain in the account and grow until the worker retires. When an employee leaves a company before age 59-1/2, he can make some choices about what to do with his 401k plan. Choices are subject to plan limitations, and not all options are available with all plans.
One of the choices for the money in a 401k plan is to roll it over into a new retirement plan. The best way to avoid taxes on a rollover is to put the money into a qualified retirement account, do a direct transfer from one account to the other so that the money avoids tax withholding, and to place the money is the new account within the allowed time limit, usually 60 days. When handled properly, a rollover will move all of the 401k funds into a new account, where it will not be subject to taxation until it is removed.
Another way to deal with a 401k after work termination is to take all of the cash out of the account. However, unless the account owner is 59-1/2, or 55 and no longer working, the money is subject to tax withholding of a flat 20 percent of the total. An additional 10 percent excise tax is added as a penalty for early withdrawal. Other costs and fees that are plan-specific may be added, such as administrative costs. This may be a necessary option for someone who needs the money to live on, but is not usually the best financial choice.
Leave It Where it is
The money in a 401k plan can often be left with the employer, even if the account owner is no longer working there. It is important to keep track of any changes the company makes, such as if the business relocates. The account owner should know important information about her plan, such as how much money she has in it and the name of the plan administrator. This information is contained in plan documents such as the summary plan description and the individual benefits statement. The company may also charge fees to administer the plan for a non-employee.
If an employer is going out of business and will no longer have a 401k plan, all of the money in an employee account will be paid to the employee. Depending on the situation, an employee may be offered the chance to roll over some or all of the money into a new retirement account. If not, the money will normally be paid as a single lump sum and taxes will be withheld. If the account owner puts some or all of the money into a new retirement account within the time frame specified by the IRS, normally 60 days, that amount will not count as part of the person’s income for the year.