It can be tempting to cut and run when you quit a job – especially if you’re leaving a particularly nasty situation. But if you have an investment account tied up with that employer, it’s important to transfer those funds as soon as possible.

Rolling over a 401(k) is relatively easy, but there are a few things you should know beforehand. We’ll break down the details in the article below.

Why You Should Roll Over a 401(k)

One of the main reasons to roll over a 401(k) is because you might forget about the account. If you switch jobs every few years and never roll over your 401(k)s, you may end up with multiple retirement accounts which can be hard to manage.

Also, some companies will charge an extra fee if you have a 401(k) but are no longer an employee. If you have less than $5,000 in your 401(k), the company may force you to move the funds elsewhere.

What to Know When Rolling Over a 401(k)

Rolling over a 401(k) isn’t as easy as it should be. Read below for the important things to know beforehand.

Decide where to roll over your 401(k)

You generally have two options when deciding where to roll over your 401(k): a new 401(k) at your current employer or an Individual Retirement Account (IRA). An IRA is a retirement account that anyone can open without needing access to their employer. 

If you deposit the funds into your new 401(k), it may be easier to manage one singular retirement account. But you will likely have more investment options and possibly fewer fees if you roll over the money into an IRA. Also, an IRA may have fewer fees than a 401(k), so you’ll reap more of the rewards of investing.

Opt for a direct rollover

Some 401(k) companies will let you initiate a direct rollover where the money is sent to your new account. The funds will be transferred without you having to manually deposit a check.

A direct rollover is much easier to handle than a manual rollover. Make sure you find out if this is an option. 

Be aware of the timeline

If you cannot do a direct rollover, then the 401(k) company will send you a check that you can deposit toward your new 401(k) or IRA. Then, you will have 60 days to deposit the funds.

If you miss that deadline and are younger than 59.5, the money will be treated as an early withdrawal. You will then have to pay a 10% penalty and income tax. If you have a Roth 401(k), you will only owe taxes on the earnings portion and not the contributions. As soon as you receive the check, deposit it immediately. 

Invest the funds

When you initiate a 401(k) rollover into a different retirement account, consider investing the funds. If you don’t, the money will sit in the money market portion, where it won’t grow in the stock market.

This is a common mistake that can result in you missing out on thousands or more in earnings. Once you move the funds, you can then set up automatic monthly contributions.

Deposit into the right account

There are two types of 401(k)s and IRAs: Roth and traditional. Generally, most people will deposit a Roth 401(k) into a Roth IRA and a traditional 401(k) into a traditional IRA.

If you deposit a traditional 401(k) into a Roth IRA, you will have to pay taxes on that amount. Depending on how much you transfer and your current tax rate, you may wind up with a large tax bill. 

If you deposit a Roth 401(k) into a traditional IRA, you’ll be giving up the tax-free withdrawals in retirement. Before you transfer the funds, make sure to roll it over into the right account.

When You Shouldn’t Roll Over a 401(k)

One time when you should consider avoiding rolling over your 401(k) is if you want to retire early. Investors can access their 401(k)s starting at age 55 without paying a 10% early withdrawal penalty. For example, if you withdraw $50,000, you won’t have to pay a $5,000 fee.

If you roll over the money from a 401(k) to an IRA, you will then have to wait until you turn 59.5 to access the funds without a fee. 

Why You Should Never Cash Out a 401(k)

It may be tempting to cash out the funds, especially if you don’t have a large sum of money. But the consequences may be more dramatic than you realize. You will likely have to pay a 10% early withdrawal penalty as well as income tax. You can use an early withdrawal calculator to see exactly how much you’ll likely pay.

Also, when you withdraw funds, you will no longer be earning money in the stock market. This could cause you to miss out on decades of compound interest, depending on when you cash out your 401(k).

Zina Kumok
Zina Kumok

Zina Kumok is a freelance writer specializing in personal finance. A former reporter, she has covered murder trials, the Final Four and everything in between. She has been featured in Lifehacker, DailyWorth and Time. Read about how she paid off $28,000 worth of student loans in three years at Conscious Coins. More from Zina Kumok

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