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401k Rollovers

You just changed jobs, or your job is gone, your bank account is dwindling, and that pot of money sitting in your retirement account at your former employer is looking mighty tempting. But the financial penalties you'll likely incur for cashing it out means some due diligence is needed before you make a final decision. What are your options? What’s the best strategy for your situation? The following is informational only and is not meant as specific advise. Seek a qualified professional before taking any action.

Option No. 1: Cashing out

By cashing out, you not only get taxed and penalized, but you also lose the earnings that money could have generated. You may not even get all of your money: Your employer is required to withhold 20% for the IRS. If you don't put the money in a qualified retirement account within 60 days, it's taxed as ordinary income. Add on a state income tax, if one applies to you. And if you are under age 59½, you may incur a 10% early withdrawal penalty unless exclusion applies.

Option No. 2: Leaving the funds behind

To leave it with your former employer, your retirement account may require a minimum balance, depending on what type of plan you have, and you will likely be unable to contribute additional money to the account.

Also, if you leave the funds in your 401(k) plan, you may be less likely to keep up with it after you're severed from the company.

There may be only one good reason to leave your retirement funds behind when you separate from your job. If your 401(k) allows you to borrow from it, letting it stay in place may provide you with a backup when your cash starts running low. Unlike a cash out, the distribution for a loan may not be taxed, as long as you repay the money. But not all plans have that option. The only limitation here is that it can only be the smaller of 50% of the balance of your account or $50,000. In other words, if you have $100,000 in your account, you can borrow $50,000. If your balance is $80,000, the most you can borrow is $40,000. Of course, there may be fees associated with this, refer to your specific retirement plan rules.

In fact, if you have a 401(k) loan outstanding at the time you leave a company, many plans require that you pay it in full right away; otherwise it's treated as a taxable distribution.

Another reason to be cautious about leaving your money behind: 401(k) plans may have fees that participants don't even know about and they may be cheaper in an IRA. While rules to increase transparency of 401(k) fees have been in the works for years, they're still a work in progress. 

Option No. 3: Doing an IRA rollover

Another way to get control of your retirement funds without the financial drawbacks is to roll them over into an individual retirement account. In a direct IRA rollover, the funds are sent straight from your 401(k), or other qualified employer retirement plan, into an IRA without you touching the funds.

The first step is to be sure you have a destination for the money (an account number for them to transfer the money into.) Typically, 401(k) plans have their own paperwork that you’ll have to get from your Human Resource Department or Third Party Administrator (TPA) who maintains the plan.

Another choice, an indirect rollover, works this way: The check comes to you, and you have 60 days to deposit the money into a new retirement account to avoid taxes and early withdrawal penalties. Your employer is required to withhold 20% for the IRS, so you will need enough cash on hand to cover the taxes on that amount. Depending upon your tax situation, you may get that money back when you file your tax return. Please consult a qualified tax professional regarding your personal tax situation.

Clearly, a trustee-to-trustee transfer of funds is usually the better option of the two.

Rolling money into an IRA opens the door for the investor to invest in a wide variety of securities products - individual stocks, bonds, annuities, managed money.

IRA rollovers may allow you to use some of the money for educational expenses -- say, to get training for a new career. Although you may have to pay taxes on the money withdrawn, it may not be subject to the early withdrawal penalty that other distributions incur. This exception does not apply to withdrawals from 401(k)s. Please consult a qualified tax professional before taking any action.

Option No. 4 

Another option would be to roll your funds into another qualified employer plan (ex. Your new employer).

Consult with the pros

A separation from your employer can be the right time to step back and re-evaluate your retirement plan. A good financial advisor can help you sort things out while you decide what to do next.  As urgent as your financial situation may seem when you're unemployed, now may not be the time to rush into a decision.

Financial Planning Services offered through Cambridge Investment Research FINRA/SIPC Fee based advisory services offered through Cambridge Investment Research a registered investment advisor.