If you leave an employer where you have a 401(k) account, you have several choices for what to do with that money. Money in a 401(k) account went in without being taxed, so it is important to aviod taxation when moving the funds. The process of moving 401(k) money to another account is called a rollover.
When you leave an employer you can usually elect to leave your 401(k) money in the account with your former employer or rollover the money to a different tax-qualified retirement account. Rollover choices include moving the 401(k) money to the 401(k) plan of a new employer, or to a rollover Individual Retirement Account, commonly called an IRA. IRA choices can be with a bank, stock brokerage account or mutual fund company.
Employer Pays Out the 401(k)
If your former employer closes out your 401(k) account and pays the proceeds to you as a check, you have 60 days from the day you receive the check to protect the money from taxation. If the money from your 401(k) account is not deposited into another tax-qualified account, you will have to pay income taxes on the full amount. If you are under age 59 1/2, an additional 10-percent tax penalty will be charged on the money not rolled into a new qualified account.
Disadvantages of a Payout
A problem with taking your 401(k) proceeds as a check from your employer is that the employer is required by law to withhold 20 percent of the account balance and send it to the IRS. If you want to roll the full value of your 401(k) account into a new account within the 60 day period, you must come up with the missing 20 percent from other sources. If you deposit the 401(k) check amount without the 20 percent, the 20 percent becomes taxable income for the year, also subject to penalties.
Avoid having any money withheld from your 401(k) proceeds using a direct rollover from your existing 401(k) account to the new 401(k) or IRA account. The direct rollover is set up before any money is withdrawn from your existing account. Establish your account with the new employer 401(k) or IRA provider and take that account information to the current 401(k) administrator to process the direct rollover. You never take possession of your 401(k) money with a direct rollover.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.