A 401k is an employer-sponsored retirement account. You make pretax contributions from your pay, and your contributions are invested. Many companies match your 401k contributions up to a percentage set by your employer. When you leave your job, regardless of the reason, you need to decide what to do with your 401k.
Continue a 401k
You might be able to leave the money in your previous employer's 401k. There's generally a minimum balance required, and you can no longer contribute to that account once you have left the company. Leaving the money in that 401k also means continuing to deal with your former employer, which you might or might not want to do. If your new employer offers a 401k, you can roll over your 401k from your old employer to your new employer, then continue contributing to your 401k.
Roll Into an Traditional IRA
An IRA is an individual retirement account that you personally own and control. Typically there's a limit to how much you contribute to an IRA each year, but that limit doesn't apply when you roll over an employer-sponsored plan into an IRA because you left your employer. The limits do apply when you make additional contributions. A traditional IRA defers taxes until you withdraw the funds.
Roll Into a Roth IRA
Rolling over your 401k into a Roth IRA is similar to rolling over to a traditional IRA. However, with a Roth IRA you pay taxes on the money when you make your contribution. The payoff for doing that is when you withdraw the money at retirement, you don't owe any taxes, regardless of how much the account grew. If you roll your 401k into a Roth IRA, you will be taxed on the rollover funds, and you'll need to pay the taxes out of your own money. If you withdraw the money to pay the takes from the 401k and you're younger than 59 1/2, you're subject to an early-withdrawal penalty of 10 percent. With both types of IRAs, you should have funds sent directly from your 401k to the IRA; otherwise your 401k custodian will withhold 20 percent for taxes.
You can cash out your IRA, but this has serious tax consequences. Not only is the distribution counted as income, which raises your overall income taxes, but your former employer is required to hold 20 percent of your withdrawal. On top of that, if you're younger than 59 1/2, you're penalized an additional 10 percent. The money will no longer grow tax-deferred, and it will no longer be there for your retirement.
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