A 401K retirement account is a benefit many receive as part of their employment. In some cases, employers provide matching funds to whatever an employee directs to the account from his paycheck. In other cases employees are left to deposit on their own without any employer share, but the option still allows saving money in a legal tax shelter.
However, the best advantage is that the 401K is owned by the employee. So when he decides to change employers, the employee has some options available: he can leave the account with the current employer’s 401K administrator, take the account to a new employer’s administrator, or transfer it to another legal tax-deferred account like an individual retirement account. Finally, the employee could cash out the account, with tax ramifications up front.
Taking the Cash
Cashing out is the most painful choice. When an employee takes a 401K balance too early, i.e. before age 59 ½, then a 10 percent early penalty applies, in addition to normal income taxes on the same amount. Further, wiping out the balance eliminates any retirement benefit the money might have offered in the future. Fortunately, an employee can reverse the decision within the first 60 days and re-deposit the funds into another 401K or an IRA. This is then treated as a legal rollover (transfer).
Transfer to Another 401K
Alternatively, an employee switching jobs has the option to transfer his balance from an old employer plan to a new employer plan. This option costs no money, just a lot of paperwork to make it happen. It allows the employee to continue saving money without losing any ground towards a retirement reserve. The employee may have to change investment options, however, since different plans have different methods and choices of investing. Some allow lots of stocks and funds while others are very limited.
It’s important to note there is a waiting period to transfer, so an employee should check the rules of his old to plan to make sure he won’t get jammed to move assets out of the old account. Also, some plans won’t accommodate transfers at all; they don’t want to deal with the reporting work to the IRS.
Transfer to an IRA
If an employee wants his funds out of an old 401K plan but not into a new one or can’t transfer, a move to an IRA account is also an option. Because an IRA is tax-deferred, no money is lost to taxes or penalties. Often, IRAs are far more flexible for investing as well, depending on the institution the IRA is established with (bank, brokerage, mutual fund company etc.). If moved to a Roth IRA, however, then taxes are due but there’s no penalty for early withdrawal.
The right choice for each person will depend on his circumstances, but avoiding taxes where possible is strongly advised. This allows retirement funds to grow to their maximum profit before being needed for living costs later on.