One of the important aspects of good retirement plan is its feature of portability or rollover. With a rollover option, when an employee leaves the company, he/she can rollover their savings from the current employer’s plan into new employer’s plan or an Individual Retirement Account (IRA).
401(k) which has been around for quite some time is one such plan. It is also one of the most popular retirement solutions available. One of the main advantages of a 401(k) is its portability where one can ‘rollover’ their current 401(k) account from their former (or soon to be former) employer to their new employer.
This feature tends to be a lot useful to the employees and saves them a lot of hassle.
Generally, 401(k) plans differ from company to company and have various features and options. One should refer to their Summary Plan Description when they are thinking about a rollover 401(k). Extreme caution must be exercised when making a rollover, as a mistake can result in taxes and penalties being levied on the rollover amount.
When an employee with a 401(k) plan with his/her current employer switches job, he/she has three main options relating to the funds of the 401(k) account. These are as follows.
- To keep the money with the former employer
If the amount in the 401(k) is greater than $5,000, an employee can choose to do nothing with the current holdings of the 401(k) account and keep the amount with their former employer. By law, the employer has to maintain the 401(k) account regardless of whether an employee works with the company or not. However, the employer may choose to charge a maintenance fee for the account. This can be a hassle or a financial drawback if the employee holds multiple 401(k) accounts.
- Withdrawing the funds
One can choose to withdraw the funds lump sum from the account when switching jobs. However, this is considered as a bad idea. Accordingly to 401(k) rules, if an employee below the age of 59 ½ withdraws funds from the account, a 10% withdrawal penalty is levied on the amount. Also, since the withdrawal amount is treated as ordinary earning, it incurs income tax according to the employee’s tax bracket. This will generally leave the employee with approximately just 60% of the total amount.
- Rollover 401(k)
Considered as the best option, with a rollover 401(k), the employee can transfer all of their funds from their former employer’s 401(k) plan account to the new employer’s 401(k) account (if the new employer offers a 401(k) plan) without incurring any taxes or penalties. Since the 401(k) plans differ from company to company, one must check with their new employer about the rollover. Also, if the new employer does not offer a 401(k) plan, the employee can rollover all his/her assets from their former employer’s 401(k) account into an IRA account.
In both cases, one has to make a direct transfer from former account to the new ones to avoid any penalties or taxes. Another point that should be noted when switching jobs or rolling over funds is that if there are any loans taken they have to be paid in full within 60 days.
These are just some of the general rules regarding 401(k) rollovers. One should take up planning early on when thinking about a rollover, preferably before switching jobs. In most cases 401(k) rollovers will work more easily if they are planned and executed before the job is switched.
