If you have a 401k plan where you work, and then leave the company for any reason, you might be able to leave your 401k funds with your former employer. However, even if you can leave your funds, it might not be your best option. Other choices include moving your 401k plan to your new employer’s plan if there is one, rolling over the money to an IRA or cashing out your funds.
Less Than $5,000
If you have less than $5,000 in your 401k plan, your former employer might not allow you to keep it there and might automatically roll your funds into an IRA. If you have less than $1,000, your employer might cut you a check for the amount. Find out what your employer’s policy is. If you have more than $5,000 in your 401k, you probably have the option of leaving your money there, but this is only your best option in certain scenarios.
Leaving your 401k money behind after you leave the company might be the best option if you are almost 55 and want to start taking money out. Once you are 55, you can take disbursements without a penalty, but if you put your money into an IRA, you must wait until you are 59 1/2 to take your money. Another reason you might leave your money with your former employer is if you like the plan because the fees are low and the investments are good. This scenario more likely occurs with large companies.
It makes sense to leave your 401k with your former employer if you think you might need to borrow money from it. But first check to see whether your plan allows this because not all plans have that option. You will not be taxed on the amount you borrow, unlike a distribution, as long as you pay the money back by the specified time. Borrowing from your 401k is not ideal, however, because once you withdraw the money, you are not earning on that money for your retirement. It is also not a good idea to leave your money behind because you cannot make any further contributions to it. Also, because you are not with the company anymore, you might miss important notifications about the fund.
Roll Over to an IRA
Many people roll over their 401k plan to an IRA after leaving the company. The best way to do this is to do a trustee-to-trustee transfer where your 401k funds go directly into the IRA. You do this by directing the company that handles your new IRA account to arrange the transfer from your former employer. The other option you have to transfer your funds to an IRA is to take a check from your old employer. However, you then have to deposit the money into a new account within 60 days or face stiff penalties. Your employer must hold 20 percent of your money for income tax reasons in case you don’t deposit the funds. If you do deposit the funds, you get the 20 percent back the next tax year. But, if you wait longer than 60 days, you are taxed on the money in addition to a 10 percent penalty.
Cashing out your 401k is not a good idea because you pay income tax and the 10 percent penalty. Most importantly, you lose your retirement money. Most people who take cash use the money for other purposes instead of putting it into another retirement account, according to author Nora Peterson on Bankrate.com.
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