Contributing to your 401k is a great way to set aside funds for retirement. All of your 401k contributions — including any matching funds from your employer — are treated as pre-tax dollars, which means your money is growing on a tax-deferred basis.
If you’re not ready to retire but you’re changing jobs, you have the option of leaving your 401k where it is, but you’ll probably miss out on important information about plan changes and investment options. You could cash out your retirement account when you leave your job but the IRS looks at that money as taxable benefits, unless you meet certain criteria, you’ll also get hit with a hefty tax penalty for an early withdrawal.
How a Rollover 401k Can Benefit You
If you want to take your retirement money with you but you don’t want to face the tax implications of an early withdrawal, there is a solution. It’s called a 401k rollover and it allows you to move funds from one qualified retirement plan to another qualified plan without incurring a tax liability. Review these three major benefits of a rollover 401k and make an informed choice about what to do with yours:
- You can continue building your retirement savings even after you leave your job.
- You’ll have control over how your retirement dollars are invested. You can move the resources from your old 401k into a new or existing retirement account, such as a traditional IRA, another qualified employee plan, a 403b account or an SEP-IRA.
- All of the funds you rollover continue to grow on a tax-deferred basis.
- You can consolidate accounts to have a clear view of your retirement picture and are less likely to forget about money left in an old retirement account.
- You might save money on fees.
401k Rollover Rules
To maintain the tax-deferred status of your money, you must make the deposit into your new retirement account with 60 days of receiving a distribution from your 401k. A potential issue with a 60-day rollover is that your employer is required to withhold federal income taxes from your 401k distribution — but you must deposit the full amount of the distribution, including the amount withheld, or that amount will be considered taxable income by the IRS.
Related: Save for Retirement With an IRA
You can avoid this problem by choosing a direct rollover or a trustee-to-trustee transfer. Here’s how to do both:
- Direct rollover: Ask your plan administrator to make the distribution payment directly to your new retirement plan or IRA. Even if he issues the distribution to you via a check made payable to your new account, you won’t have federal income taxes withheld so you won’t incur a tax liability.
- Trustee-to-trustee transfer: Ask your new plan administrator to request a transfer of funds from your old 401k administrator. A trustee-to-trustee transfer keeps you out of the middle of the transaction and doesn’t require any tax withholding.
The IRS operates on a “pay now or pay later” basis. In some circumstances, you might find it advantageous to pay income taxes on your 401k distribution now and maintain the benefits of tax-free growth by rolling your 401k into a Roth IRA, which you fund with post-tax income.
Roll Your 401k Into a Down Payment
You can use your 401k funds to help put a down payment on your dream home. If you meet the qualifications for a first-time homebuyer, you can conduct an IRA rollover from your 401k, then withdraw the funds from your IRA to use to use for your down payment, according to the IRS. You will still have to pay ordinary income taxes on the amount withdrawn, but you can avoid the additional 10 percent tax penalty on early withdrawals.