Make the most of your 401k options
If you make the wrong moves with your retirement account when you change jobs, you could inadvertently reduce your retirement income.
It's a fact: The average American holds nine different jobs before the age of 34, according to the Bureau of Labor Statistics. It's also a fact that the decisions you make about how to manage retirement assets when changing jobs can have a direct impact on your future financial health.
Case in point: "Cashing out" retirement plan assets before age 59½ (55 in some cases) can expose your savings to immediate income taxes and a 10% early withdrawal penalty. On the other hand, there are several different strategies that could preserve the full value of your assets while allowing you to maintain tax-deferred growth potential.
Many of the folks we work with look for the opportunities to have as many investment options as possible available to them. Therefore most of them have looked to option No. 3 below. (Are you saving enough for retirement? Try MSN Money's calculator.)
Here are four options:
Leave the money where it is. If the vested portion of the account balance in your former employer's plan has exceeded $5,000, you can generally leave the money in that plan. Any money that remains in an old plan still belongs to you and still has the potential for tax-deferred growth. However, you won't be able to make additional contributions to that account. Post continues after video.
Transfer the money to your new plan. Here you may be able to roll over assets from an old plan to a new plan without triggering any penalty or immediate taxation. A primary benefit of this strategy is your ability to consolidate retirement assets into one account.
Transfer the money to a rollover IRA to avoid incurring any taxation or penalties. You can enact a direct rollover from your previous plan to an individual retirement account or IRA. (Withdrawals will be taxed at ordinary income tax rates. Early withdrawals may trigger a 10% penalty tax.)
If you opt for an indirect transfer, you will receive a distribution check from your previous plan equal to the amount of your balance minus an automatic 20% tax withholding. You then have 60 days to deposit the entire amount of your previous balance into an IRA, which means you will need to make up the 20% withholding out of your own pocket. You will receive credit for the withholding when you file your next tax return.
If the rollover check is made payable to your new custodian, the 20% rule will not apply. (Should you convert to a Roth IRA? Try this calculator.)
Take the cash. Because of the income tax obligations and potential 10% penalty described above, this approach could take the biggest bite out of your assets. Not only will the value of your savings drop immediately, but also you'll no longer have that money earmarked for retirement in a tax-advantaged account.
As you can see, some of these 401k transfer options can be very costly. Make sure to see a certified financial planner or a tax professional to help you avoid what could be an enormous tax trap.
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Editor Bev O'Shea lives and works in the foothills of the Appalachians. A former copy editor for The Atlanta Journal-Constitution and the Orlando Sentinel, she joined MSN Money in 2007. She's a fan of sunsets, college football and free shipping, among other things.
Having worked as a writer, reporter and editor for more than 25 years, Editor Julie Tilsner is the sort of person who can't help but correct grammar in Facebook postings and on billboards. She's written for BusinessWeek, the Los Angeles Times, Parenting, Redbook, AOL and others. She lives in Los Angeles County with her family and loves to drink wine and practice yoga, although not generally at the same time.
A writer for MSN Money since January 2007, Donna Freedman won regional and national prizes during an 18-year newspaper career and earned a college degree in midlife without taking out student loans. She also writes about smart money tactics for magazines and on her own site, Surviving and Thriving.
Mitch Lipka has been warning people about scams and shining light on questionable business practices for more than 20 years. Mitch, the consumer columnist for The Boston Globe, has also been a reporter and editor at The Philadelphia Inquirer, Consumer Reports, South Florida Sun-Sentinel and AOL. He won the 2010 New York Press Club award for best consumer reporting online and was honored in 2011 for his reporting on child product safety.
Marilyn Lewis is an award-winning writer with a passion for getting readers clear, straight information that helps them stay out of financial trouble. A former reporter for The San Jose Mercury News, she works from her home in Port Townsend, Wash. Contact her at MarilynLewis@Outlook.com.
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