Retirement Options: 401(K) Plan Options Upon Leaving A Job

401(k) plan options: what should you do with your 401(k) plan money when you leave your job? Learn what the alternatives and tax consequences are.

You've just accepted a great new job. Now, what should you do with the money in your former employer's 401(k) plan? Should you leave it with the employer, transfer the money to your new employer's 401(k) plan, cash out the fund, or roll it over into an IRA? You should know the pros and cons of each option, and the serious tax consequences involved before you decide what to do with your 401(k) plan.

If you decide to leave the money in your 401(k plan with your former employer, you may not have the flexibility to decide what happens to that money. However, the advantage is that you will not face any tax penalties by leaving the money where it is. You may want to consider leaving the money with your former employer if you are happy with the investment vehicles you have selected, and the plan has options you cannot get in another retirement plan. You may want to consider taking the money out if the employer limits access or restricts the plan because you are no longer an employee.

If you decide to transfer the money to your new employer's 401(k) plan, you should know the rules involved to roll the money over. You are allowed to roll over pre-tax contributions and any earnings in the fund into your new employers tax deferred retirement savings plan. You are not allowed to roll over after-tax contributions. Your new employer may require that you work for them for a period of time before you are eligible to invest in their pension plan.

Another option is to open a rollover IRA. A rollover IRA allows you to transfer money from an employer-sponsored retirement plan without incurring any tax or early withdrawal penalties. The early withdrawal penalty is 10% of your fund's balance if you are younger than 59 1/2. The advantages of a rollover IRA are that you have control over the account and you can invest the money however you like. Also, you have the option of transferring the money in the rollover IRA to your employer's retirement plan provided that you do not make any contributions to your rollover IRA.

You might be tempted to forget about saving the money for retirement and cash out your 401(k) plan. However, you should consider the painful tax consequences before you do this. First, your employer will withhold 20% for prepayment of federal taxes. If you are in the 36% tax bracket, you may face paying an extra 16% of income tax. Also, if you are younger than 59 1/2, you will pay an extra 10% penalty for withdrawing the money early. Altogether, you could end up losing 46% of your hard-saved money to taxes and penalties. In addition, you will lose the security of having money put aside for your retirement.

Now that you know the pros and cons of each option, you can decide what to do with your 401(k) plan money. This should make the transition to your new job much easier.

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