What to Do with Your 401k Plan after Leaving Job? 401k Rollover IRA

Unlike past eras, it’s doubtful you’ll spend your career with the same employer. When you’re ready to move on, you’ll face some important decisions about what to do with your 401(k) plan. Essentially, there are four choices when you’re ready to take a hike:

1. Take the money and run.
2. Leave the money in your employer’s pension plan.
3. Move the money to your new employer’s plan.
4. Roll the money over into an IRA.

Taking the money is usually the worst choice. You may be hit with a 10 percent penalty, as well as federal and possibly state taxes on the money. You’ll also lose thousands of dollars down the road because that money won’t be growing in the tax-sheltered account. Even a small amount of money will grow significantly over the years. Research shows that people with small distributions usually do not roll them over into a retirement account.

A second option is to leave the money where it is. This makes sense if your former employer offers investment choices that appeal to you. Make sure there are no administrative fees for non-employees and that the rules are basically the same. If your 401(k) account is small, you may be forced to take the money elsewhere. If you leave the money where it is, there are no tax consequences.

If you’re going to work elsewhere, consider transferring your lump-sum distribution to the new employer’s plan. Most companies with 401(k) plans will accept rollovers from your previous employer. Because you’re rolling the money from one plan to another, you won’t pay any taxes.

If you’re finished working or you don’t like the investment choices at your new employer, the money can be transferred directly to an IRA at a bank, brokerage firm, or mutual fund company. It’s best for the money to be transferred directly from your employer to the new IRA. Otherwise, the employer will be required to withhold 20 percent and you might also get smacked with the 10 percent early withdrawal penalty.

The safest bet is a direct rollover to an IRA. The IRS is happy, because you haven’t touched the money. If you take possession of the funds, the money must be rolled over within 60 days or you face some significant tax consequences. As a general rule, if you’re under age 59 1/2, you’ll pay a stiff 10 percent penalty in addition to the normal taxes on the money withdrawn.

It’s important to note that you can’t roll over your money directly into a Roth IRA, which allows tax free withdrawals. If money were to go directly to the Roth IRA, the IRS wouldn’t get its hands on any of it. Because your 401(k) contributions were made before taxes were taken out, the government won’t let that money find its way to a tax-free account until its share is taken.