401k Rollovers and Job Changes
People with established 401k accounts must decide what to do with funds in their account when they leave their job and start working for a new employer. The Internal Revenue Service categorizes 401k accounts alongside Individual Retirement Accounts as tax-deferred retirement vessels. Technically people can access the money prior to retirement age, but doing so leads to a tax penalty. People who rollover funds avoid exposing the 401k funds in taxation.
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Keep the Money in a 401k
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Some companies allow new employees to rollover funds from 401k accounts at their previous employer. A direct rollover involves the old 401k custodian liquidating the account and sending it directly to the custodian at the new employer. The funds are then combined with new contributions in the new employers 401k plan. Alternatively, a former employee with more than $5,000 in a 401k account can elect to leave funds in the old account indefinitely. People do this if their new employer does not allow new employees to immediately enroll in the 401k plan.
Traditional Individual Retirement Account
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401k accounts contain pretax contributions and are therefore funded in the same way as traditional Individual Retirement Accounts. Consequently, the IRS allows plan participants to rollover 401k funds into traditional IRAs. Investors can use a variety of different investment products to house traditional IRA funds. People close to retirement age often rollover 401k accounts into annuities that generate income streams during retirement. Conservative investors can rollover funds into certificates of deposit that are insured by the Federal Deposit Insurance Corporation. Other options include buying mutual funds, stocks and bonds.
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Rollover Tax Complications
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Whenever possible, people rolling over 401k funds to the new employer's plan or into an IRA should attempt to set up a direct transfer between the custodians. Some custodians prefer to issue a check directly to the plan participant and the participant has to give the check to the new custodian. The IRS allows people 60 days to complete these transactions, but, crucially, the IRS requires the old custodian to withhold 20 percent of the funds to cover withholding tax. Investors must replenish the amount using other funds and claim back the withholding amount when they file their federal taxes.
Outstanding Loans
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The IRS enables 401k plan participants to take out 401k loans for a variety of different purposes. If someone with an outstanding 401k loan changes jobs, the rollover cannot occur until funds have been repaid. Normally the repayment has to occur within 90 days or the plan custodian terminates the account and disburses funds as ordinary income. People who are willing and able to repay the entire loan balance can do so and then rollover funds to a new 401k or IRA.
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