401K Rollover Questions Answered
“I’ve been laid off. What’s going to happen to my 401k?”
The Employee Retirement Income Security Act of 1974 (ERISA) protects the assets of millions of Americans so that funds placed in retirement plans during their working lives will be there when they retire. This means that you are entitled to all of the money you’ve contributed into your 401k. In addition, your tenure determines how much of your former employer’s matching contributions you are entitled to. Chances are you are 100% vested if you have worked at the same place of employment for a few years.
“What are my 401K rollover options?”
You have the choice of leaving the 401k funds in your current plan, cashing out of the plan, or rolling the funds over into another qualified retirement account such as an IRA.
Option 1: You may choose to leave your money in your old 401k account.
This may sound like the simplest option, but it may not be the best solution for you in the long term.
- Beware of incurring additional expenses. Your former employer may not want to deal with administering your account and may pass these expenses on to you.
- You may find it difficult to get assistance when you need it.
- While we do not recommend borrowing against your 401k balance, staying in your current plan may prevent you from doing so. This leaves you with less flexibility.
- Keeping this “orphan” account means that you may have a separate account to track and manage. Rolling over your 401k funds into an IRA consolidates your accounts. See Option 3 for additional details.
Lastly, you need to be aware that if your 401k account balance is below a certain minimum, your former employer may choose to simply close your account and send you a check. While you may initially see this as a windfall of “free money,” this triggers tax consequences as outlined in Option 2.
Option 2: You may cash out your 401k.
If you choose to cash out your 401k without designating another qualified retirement account, your former employer is required to withhold and send 20% of your money to the IRS. If you do not deposit your money into a qualified retirement account within 60 days, you will have to pay taxes PLUS a early withdrawal penalty of 10% if you are under the age of 59 1/2. In addition, you will have to come up with money out-of-pocket to make up for 20% that was withheld to the IRS. You will not be able to recover the money withheld to the IRS until you file your next tax return.
Option 3: You may roll over your 401K money into a Qualified Retirement Account.
- Direct Rollover – Also known as a trustee-to-trustee transfer, this option is the most simple and direct way to rollover your 401k money. There are no taxes, withholding, or penalties. A check is simply sent from your current 401k plan to the designated retirement account such as your new employer’s 401k (if you’ve found a new job right away) or an IRA. If you do not have an IRA, we can assist you with opening one.
- Indirect Rollover – If you choose to do an indirect rollover, you will receive a check MINUS the 20% that is required to be withheld by your former employer and sent to the IRS. The rules, taxes, and penalties described above in Option 2 apply here. Here is an example of what happens in an indirect rollover: If your 401k account balance is $100,000, you will receive a check for $80,000. Your former employer will send the IRS $20,000. You must send your new IRA custodian a check for the full $100,000 within 60 days in order to avoid taxes and the 10% early withdrawal penalty if you are under the age of 59 1/2. This means that you must come up with $20,000 out-of-pocket to avoid paying taxes and penalties. You will receive the extra $20,000 from the IRS when you file your tax return.