How Does a 401(k) Rollover Work?
Many employers offer a 401(k) savings plan as part of their standard benefit package. Some employers match some or all of the employee's contribution to the 401(k). 401(k)s comes in two different varieties, the standard 401(k) and a Roth 401(k). Standard 401(k)s allow the employee to delay paying income taxes on the money deposited into the 401(k) until retirement. Once retired, the employee withdraws the income from a 401(k) and the government taxes it at the new, and hopefully lower, tax rate.
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Leaving a Company
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When an employee leaves an employer, whether to go to another job or to retire, the employee has the option to roll over the 401(k) out of the company's control and into the employee's control. A standard 401(k) usually rolls into a standard IRA and a Roth 401(k) rolls into a Roth IRA. By rolling over the 401(k), the employee assumes control of the funds. Most 401(k) programs do not allow former employees the ability to make changes to their 401(k) investment plan.
Avoiding Penalties and Taxes
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The employee hires a brokerage firm that rolls over the 401(k) into an IRA. The money must leave the 401(k) and move directly into the IRA without going into the employees hands. If the employee receives the funds before depositing it into an IRA, it may be subject to taxes and early withdrawal penalties. The broker will help the employee of roll over the 401(k) correctly and avoid taxes and penalties.
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Choosing Investments
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One major benefit of rolling over your 401(k) into an IRA is the ability to manage the investment. Ask your brokerage consultant to provide a prospectus of your investment options. You should have options available from safe investment styles, which provide relatively small rates of return, to riskier investment styles, which may provide higher rates of return. Talk with your brokerage consultant as you choose the right investment vehicle for you.
Accessing Funds Before Retirement
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There are some situations where you may access the funds before retirement without penalties. You may borrow money from your retirement without paying either taxes or penalties as long as you pay it back. You may also withdraw funds and avoid the penalty when you use the funds to buy a primary residence, prevent foreclosure or eviction, or pay college tuition for yourself or a dependent. You may also pay medical expenses that aren't reimbursed for you or a dependent. Consult a tax professional to ensure you qualify before withdrawing funds from your 401(k) or IRA.
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