One of our specialties is handling 401k rollovers.
When the time comes to change jobs or leave an employer that has offered a 401k plan there are a few very important items that require consideration. Making the right choices now will make a considerable difference in the value of your assets in the future.
Understand the terms of your current 401k account. In many cases you will be limited in your investment options within the current plan and you may be charged administration fees that are often higher than what can be found in IRA (Individual Retirement Account) plans. Some employers do not offer the choice of remaining in their plan and require you to move your plan dollars elsewhere within a certain period of time. Another important point to clarify is whether your employer’s contributions are vested. Review the employer’s 401k plan carefully to determine whether your conditions of employment have satisfied the vesting requirements of the plan. It is often difficult to determine the fees and expenses that are collected from your savings on an annual or quarterly basis.
About withdrawing the funds to invest on your own: Taking cash even if you’re planning to re-invest the money is a mistake unless you’re willing to sacrifice a minimum of 20% of your investment dollars before the funds are turned over to you. Your 60-day option to reinvest the funds, if exercised, will save you any tax or penalty, but be careful. You’ll have come up with the 20% that was withheld out of your own money or the 20% not rolled over is fully taxed and possibly penalized.
BEWARE: You are only allowed to to do ONE rollover in each calendar year. Your first one is free of tax and penalty. Any and all rollovers after that first one are fully taxable at your highest tax bracket and possibly subject to the 10% penalty, depending on your specific situation. Here’s a horror story I recall from 20 years ago: A guy left his employer and took his 401K money out and rolled it over into his IRA. That was belfore the IRS mandated the automatic withholding of 20%. Problem was, he forgot that earlier in the same calendar year he had done a rollover of a small IRA he had set up years prior at a bank. It was only a couple of hundred dollars, but unfortunately, it counted as his first and only allowed rollover in that calendar year and the IRS hit him with the tax and 10% penalty on the full amount of the second rollover, which was several hundred thousand dollars. Bottom line, the net cost was over $100,000 and there was nothing he could do about it.
A better option is always to perform a direct rollover. The funds will be transferred straight to your new retirement account by the organization that currently manages the 401k for your employer. Those transfers will not be penalized for the 10% early withdrawal, will not be subject to the 20% withholding, are not restricted to one per year and will not be taxed at any rate.
About withdrawing the funds to use as cash: This action will cause the withdrawn amount to be taxed at your highest rate and may be subject to an additional 10% penalty. All too often, individuals lose their job or change jobs and receive their 401k statement. Receiving the 401k statement after losing a job comes across to many as just the relief that is needed. If you’re able to get by without that money, you absolutely should not touch it. Speak with a financial adviser about your options before considering a withdrawal. If you must take a withdrawal, seriously consider taking only a portion out, and rolling the rest into an IRA. Hard times are understandable but are often short-lived when compared to the length of your working career. Make note of this comparison to put things in perspective: A cash withdrawal of $10,000 may only provide you with $6,000 now, whereas leaving the money in an investment that collects 8% annually for 25 years will be valued at over $68,000. Think of it this way: is having that $6,000 now worth forfeiting $68,000 at retirement?