Now that I told everyone about my plans to quit my job and move onto full time blogging, it’s time to look into how I should handle my current 401k account once I leave the company. As I don’t have a huge 401k account balance, the penalty if I don’t do anything will be small but this doesn’t mean that I don’t spend time on this. Managing our finances successfully means making sure that we take care of all the little things so let’s explore what I can do with my 401k.
Options, Options, Options
Roll the Money into a New 401k
If you are changing jobs, you can always roll the money into the 401k plan at the new job. This is generally a good approach if your new employer has good fund selection. In my situation however, I am going out on my own so this is not really an option for me.
Get Cash Now
I can elect to have my plan administrator write me a check for my entire 401k amount. In fact, this is the most popular option in the United States. Unfortunately, this is also the worst possible option. If I choose to cash out my 401k balance, not only will 20% of the entire account be deducted for tax purposes, 10% more is due as a penalty come tax time next April!
Leave My 401k Plan at My Current Employer
There’s always the option of leaving my 401k plan at my current employer. This is not a very good way of handling my 401k because I can never add funds to the 401k plan. Add to the fact that my current 401k plan doesn’t have great investment options, I’m not considering this option.
Turn it into an IRA
The most natural approach seems to be rolling over my funds into a IRA account. If I do this, I would ask my plan administrator to transfer the funds to my new IRA plan and I would never have to handle the money.
This way, there is no taxes or penalties. If I choose the home of my new plan correctly, I should also gain access to a much wider selection of investments.
If the plan administrator end up mailing me the check, I still don’t need to worry as long as the check is payable to the new plan and not to me. Once I receive the check, I can just bring it to my contact for the new plan and he/she will get the funds deposited into my account.
One Caution
If I forget to talk to the plan administrator about my 401k plan and a check for the account balance minus 20% upfront penalty is mailed to me, there is still a way to not get penalized! The government allows a 60 day window from the time I receive the check to find a new home for my 401k balance. I just need to make sure that instead of depositing the amount of the check, I come up with the 20% penalty with my own money and add that to the new plan. As long as the ending balance of my 401k plan and the opening balance of the new plan is the same, the government will give me a tax credit for the 20% they withheld when the check was mailed to me!
What I Think I Will Do With My 401k
Since I cannot change my 401k plan directly into a Roth IRA account, I will probably turn my 401k plan into an traditional IRA, then try to turn it into a Roth IRA at a later date. If you want to know about Roth IRAs, stay tuned as I will give you an update when I start planning that switch over.
- E*Trade IRA - Official Site
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{ 11 comments… read them below or add one }
I like your plan. The IRA should give you more control over your plan as time marches on from the time you leave your current employer. And, you can convert it over to a Roth IRA when tax situations are favorable to do so. Smart plan.
Frugal Dad: Thanks
It’s great to know that someone acknowledges my plan.
I don’t remember the exact details but I remember something like 2009/2010 there’s a way to roll them over more efficiently. I will have to look into it. I guess though that come 2009, my income will be lower without my primary job so it might make sense to do it next year.
I was in your position just a few months ago and I thought I couldn’t roll over into a Roth IRA without converting to a traditional IRA first, but I ended up being wrong. I just have to pay taxes on it this year.
I went ahead opened the Roth because I have a relatively small balance now and it will cost me a lot less money than paying taxes on the distributions had I rolled it into a traditional IRA.
Indeed, usually the most convenient thing is to do a direct rollover into a rollover IRA account, either pre-existing from previous 401(k) transfers, or a new rollover account. This is special and different from your regular IRA account. A direct rollover avoids the problem of coming up with 20% of your own cash.
You can now (2008) convert a rollover to a Roth IRA, but there are some income caps that are all to easy to reach, especially for a married couple since the limits are the same for single/married. In 2010 those limits vanish. More info on the above fairmark website.
Capital Couples Finance: Good to know! I will have to research on that and see whether it makes sense for me to go directly to a Roth IRA. The only thing for me to do this is that I’m going to have a much smaller income next year and I may be able to save more taxes next year.
Steve Bonds: I will seriously have to look into it. The income cap wouldn’t be a problem for me next year since I’m quitting my primary job and my biggest source of income.
Absolutely avoid just taking the cash and incurring the penalty. I know people that have done that and it’s been throwing it out the window in my opinion. It’s money that you set aside that you had no intention of touching, but then, just due to a life/career change, your Net Present Value decreased by 10%.
I’d roll over:
1) More control
2) Better investment options
3) Lower fees – Vanguard is best in the industry and many 401K plans don’t offer, so I assume yours doesn’t.
On the rollover Traditional vs. Roth, there are some considerations as to whether your income (and hence tax rate) will be higher in your working years or retirement years to offset paying the taxes now. The next election/Congress leaves some uncertainty as well. Tough call, I’d probably opt to do the traditional IRA rollover and incur no tax payments now.
Roll it into the IRA is my vote! Better management, more funds, easy transfer, tax-friendly. No question if/when I quit for blogging.
I don’t have much knowledge about the tax and 401k, but I think this 401k is useful for our retirement life.
Should you take your 401k out at 70 when you are still working. What do I put it in if I should and when do I have to start drawing it out.
esthermasters: If your 401k is with the employer you are still working with, you can delay withdrawals until you retire. However, if you have any funds in your IRA, you must make the minimum withdrawal when you turn 70 and a half.
As to where you put it in, it depends on how much you already have outside of retirement funds as well as how long you plan to work. If you have a solid savings, you might want to invest it in stocks and bonds. If you don’t, then maybe it’s finally time to build some savings.
Well put!
Anytime you have to leave a job, your 401k should be a priority. I have heard horror stories about individuals who make the wrong moves, and this article lays out a few of the big nono’s.