What Happens If I Cash Out My 401
If you simply cash out your 401 account, you’ll owe income tax on the money. In addition, you’ll generally owe a 10% early withdrawal penalty if you’re under the age of 59½. It is possible to avoid the penalty, however, if you qualify for one of the exceptions that the IRS lists on its website. Those include using the money for qualified education expenses or up to $10,000 to buy a first home.
What Can You Do With An Old 401
When you leave an employer and have a 401 or another tax-preferred retirement account such as a 403 or 457 you generally can do one of three things:
There are a few considerations and caveats for each option.
Do I Have To Pay Taxes When Rolling Over A 401
Whether you owe taxes on a rollover depends on whether youre changing account types . Generally, if you move a traditional 401 account to a Roth IRA, you could create a tax liability. Here are a few scenarios:
- If youre rolling over money from a traditional 401 to another traditional 401 or traditional IRA, you wont create a tax liability.
- If youre rolling over a Roth 401 to another Roth 401 or Roth IRA, you wont create a tax liability.
- However, if youre rolling a traditional 401 into a Roth IRA, you could create a tax liability.
Its also important to know that if you have a Roth 401 that has any employer matching funds in it, those matching funds are categorized as a traditional 401 contribution. So if you transfer a Roth 401 with matching funds into an IRA, youll need to create two IRA accounts a traditional IRA and a Roth IRA to avoid any tax issues during the rollover.
Of course, youll still need to abide by the 60-day rule on rollovers. That is, you have 60 days from the date you receive a retirement plan distribution to roll it over into another plan, according to the IRS. Taxes generally arent withheld from the transfer amount, and this may be processed with a check made payable to your new qualified plan or IRA account.
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Decide Where To Open Your New Ira
When opening an IRA, most people will look towards a brokerage, and for obvious reasons. 401 accounts are notorious for their relatively limited investment selections. But by rolling your funds into an IRA at a brokerage, youll get to choose from a significantly larger pool of potential investments. In fact, many offer some combination of stocks, bonds, exchange-traded funds , mutual funds, options and more.
Managing your own retirement funds takes a lot of time and energy, but a financial advisor can do it for you. Many financial advisors specialize in retirement planning and investing, which is exactly the combination youll need. If you go this route, your advisor will manage your investments in an IRA according to your needs and current savings situation.
If you prefer an even more hands-off approach to investing, a robo-advisor could be a good option. When you open an IRA with a robo-advisor, an asset allocation profile will be created for you based on your age, risk tolerance and proximity to retirement. The robo-advisor will then invest and manage your assets for you according to this plan.
Regardless of which way you go, make sure you understand any account, investment or advisory fees you may incur. An overbearing fee structure can have an extremely negative effect on your portfolio, so keep an eye out for this.
What To Do With An Old 401
Its natural to be excited or nervous when changing jobs. Youre probably as thrilled as you are wary. And if youre retiring, its the same way. So while saying goodbye to your old job, dont forget to move the funds from the 401 or 403.
Because your 401 may be a significant portion of your retirement funds, its crucial to consider the benefits and drawbacks of each rollover option before making a selection.
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Begin The Rollover Process
Youll have to fill out paperwork to conduct your rollover, and it may require some back-and-forth conversations with your providers. You have several options to actually move the money from the old provider to the new one, but your best option is a direct rollover.
In a direct rollover, the funds are sent straight from your 401 into your new account without you touching the funds. Its important that you specify a direct rollover so that you dont have the check made payable to you. You could trigger a mandatory 20 percent withholding for taxes, and the IRS charges a 10 percent bonus penalty on withdrawals made before age 59 1/2.
Option : Cashing Out Your 401
While withdrawing your money is an option, in most circumstances, it means those funds will not be there when you need them in retirement. In addition, cashing out your 401 generally means you’ll have to pay taxes on the withdrawal, and there’s typically an additional 10% tax penalty if you’re younger than 59½, unless you left your employer in the calendar year you turned 55 or older.
Net unrealized appreciation: special considerations for employer stockIf you own stock in your former employer and that stock has increased in value from your original investment, you may be able to receive special tax treatment on these securities. This is referred to as net unrealized appreciation . If you roll the employer stock into a traditional or Roth IRA or move it to your new employers plan, the ability to use the NUA strategy is lost. NUA rules are complex. If you’re considering NUA, we suggest consulting with a tax professional prior to making any decisions on distributions from your existing plan.
Should I roll over my 401?The decision about whether to roll over your 401 is dependent on your individual situation. A financial advisor will work with you to help identify your goals and determine what’s important to you. By understanding your investment personality, he or she will be able to advise if rolling over your 401 is the best option for you.
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How The Rollover Is Done Is Important Too
Whether you pick an IRA for your rollover or choose to go with your new employer’s plan, consider a direct rolloverthats when one financial institution sends a check directly to the other financial institution. The check would be made out to the new financial institution with instructions to roll the money into your IRA or 401.
The alternative, having a check made payable to you, is not a good option in this case. If the check is made payable directly to you, your plan administrator is required by the IRS to withhold 20% for taxes. As if that wouldn’t be bad enoughyou only have 60 days from the time of a withdrawal to put the money back into a tax-advantaged account like a 401 or IRA. That means if you want the full value of your former account to stay in the tax-advantaged confines of a retirement account, you’d have to come up with the 20% that was withheld and put it into your new account.
If you’re not able to make up the 20%, not only will you lose the potential tax-free or tax-deferred growth on that money but you may also owe a 10% penalty if you’re under age 59½ because the IRS would consider the tax withholding an early withdrawal from your account. So, to make a long story short, do pay attention to the details when rolling over your 401.
Invest Your Newly Deposited Funds
You’ll have to choose investments in your new IRA so your money can grow. Make sure to maintain an appropriate asset allocation given your age, and consider your risk tolerance.
Finally, when your new IRA has been opened, be sure to read up on common IRA mistakes to avoid, such as forgetting required minimum distributions, not designating beneficiaries, and trading too often in the account.
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Benefits Of Rolling Over Your 401k To An Ira
A common misconception about 401k plans is that if you leave your funds in the account after leaving the employer, you will continue to receive matching contributions or continue to vest the previously added match. We hate to be the bearers of bad news, but thats not the case. Not only will you not receive any matching contributions, but you wont be able to contribute to your old 401k at all.
So for most, the decision is clear: roll over your 401k assets into an IRA.
However, there are specific scenarios when a cash-out might make sense, such as if you own stock in your company in your 401k. Additionally, some scenarios may cause high-income earners to encounter a taxable situation when attempting a backdoor Roth conversion after rolling over a 401k into an IRA. If you think this might apply to you, talk to your financial advisor about your rollover options.
Its Your Money And Your Choice
When it comes to what to do, there are advantages and disadvantages to all options so theres no one right answer for all. You need to review your options and choose whats best for you and your retirement. Retirement savings is one of the most important and long-lasting investment decisions youll ever make. If youre not sure what to do, you always have the option of talking to an advisor. Whether you need a bit of advice or a comprehensive financial plan, a Certified Financial Planner can help guide you in the right direction.
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What To Do With Your Old 401 When You Quit And Why It Matters
Getty Images/JGI/Jamie Grill
One common question when leaving a job is what to do with the old retirement plan. Whether you leave involuntarily, quit to start a new job, or see yourself switching jobs several times in the next few years, you need a plan for your former employer’s retirement savings plan. That’s your 401, 457 or 403.
One wrong move can cost a big chunk of your savings, so you need to be ready to take the right steps.
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Your Age And Your 401 Rollover
In most cases, if you make withdrawals from your retirement account before age 59.5, you will owe both taxes and penalties. However, rolling over your plan to an IRA or another retirement account is not a taxable event and will not incur taxation or penalties at that time.
But if you are leaving your job around the time you turn 55 , you can avoid the 10% early withdrawal penalty. Of course, the withdrawal will still be taxable. Unfortunately, the “55 rule” does not apply to IRAs. For IRAs, a penalty-free withdrawal generally won’t be permitted until the account holder is 59½.
Option : Move The Money To Your New Employer’s 401 Plan
Moving money to your new employers 401 may be an option, depending on whether your current employer has a 401 plan and the terms of the plan. Like your former employer’s plan, many factors ultimately depend on the terms of your plan, but you should keep the following mind:
- Ability to add money: You’ll generally be able to add money to your new employer’s plan as long as you meet the plan’s requirements. This option also allows you to consolidate your retirement accounts, which may make it easier to monitor your investments and simplify your account information at tax time.
- Investment choices: 401 plans typically have a more limited number of investment options compared to an IRA, but they may include investments you can’t get through an IRA.
- Available services: Some plans may offer educational materials, planning tools, telephone help lines and workshops. Your plan may or may not provide access to a financial advisor.
- Fees and expenses: 401 fees and expenses often include administrative fees, investment-related expenses and distribution fees. These fees and expenses may be lower than the fees and expenses of an IRA.
- Penalty-free distributions: Generally, you can take money from your plan without tax penalties at age 55, if you leave your employer in the calendar year you turn 55 or older.
- Required minimum distributions: Generally, you must take minimum distributions from your plan beginning at age 72, unless you are still working at the company.
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Can I Take Money Out Of My Ira Before I Reach Retirement
Yes. And you don’t have to pay it back like you would with a loan from your employer-sponsored plan.
However, withdrawals you make before age 59½ may have consequences:
- Roth IRA: There’s a 10% federal penalty tax on withdrawals of earnings before age 59½. Withdrawals of your contributions are always penalty-free.
- Traditional IRA: There’s a 10% federal penalty tax on withdrawals of contributions and earnings before age 59½.
There are some exceptions** to the 10% penalty, so be sure to check the IRS website for details.
Check Your Account Value
If your balance in your former employers 401 plan is over $5,000, you have a full gamut of options: You can leave the money behind in the old plan, assuming the plan allows it, or roll the assets into an IRA or your new employers 401 . Move on to Step 2.
But if your balance falls below that $5,000 threshold, some of the decision-making may be out of your hands. Whatever you do, make every attempt to avoid pulling the money out of the confines of a 401 or IRA otherwise, youll pay taxes and a 10% penalty if youre under age 55. This article discusses your options for 401s under the $5,000 threshold.
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Option : Roll Over Your Old 401 Into An Individual Retirement Account
Still another option is to roll over your old 401 into an IRA. The primary benefit of an IRA rollover is having access to a wider range of investment options, since youll be in control of your retirement savings rather than a participant in an employers plan. Depending on what you invest in, a rollover can also save you money from management and administrative fees, costs that can eat into investment returns over time. If you decide to roll over an old 401 into an IRA, you will have several options, each of which has different tax implications.
Determine What To Invest In
Thus far, weve focused on logistical matters. But if youve decided to roll over your assets from an old 401 to another 401 or IRA, youll also have to determine how youll allocate those assets.
If all of your retirement assets were in your old 401, a sturdy target-date fund is a one-stop, low-maintenance choice that you can hold into retirement. The target-date series from Vanguard and BlackRock are among Morningstar analysts favorites.
If your old 401 is just one of several accounts geared toward retirement, a rollover can be an ideal time to check up on how all of the pieces fit togetherand where you have holes. Enter all of your retirement holdings ) into the portfolio tool in Morningstar Investor, then assess your current asset allocations relative to your targets. No targets? This article provides some guidelines.
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Determine Whether To Stay Within The 401 Confines
Assuming your balance is over $5,000, your next task is to decide whether to roll the money into an IRA or keep it inside a 401either that of your former employer or that of your current one. Leaving the money behind or rolling it into your current employers 401 may or may not be allowablethe specific bylaws vary by plan, so check on that first.
Because of the layer of fees and subpar, high-cost choices that can sometimes accompany 401s , I often recommend rolling over the assets from a former 401 into a no-fee IRA with a topnotch mutual fund company or discount broker. You can put almost anything you like within an IRA, and youll usually be able to avoid any administrative fees if you shop around.
But switching out of the confines of a 401 isnt always the right answer. Some people value the extra creditor protections that can accompany 401 assets versus IRA assets , while others may prize 401-specific investment options, including stable-value funds and ultra-low-cost institutional share classes. And if rolling the money out of the 401 means investing with a high-cost advisor in high-cost investment options, leaving the money behind in the 401 is the better option. This article outlines some situations when remaining in a 401 is advisable.
If youve determined its best to stay put in a 401, go to Step 3.
If youve decided to roll your 401 assets into an IRA, go to Step 4.
