If you have been saving in a 401K, provided by your employer but have either lost your job or moved on for a better opportunity, then you have an important decision to make. Should you leave your money where it is or roll (transfer) it to another account? And how do you do it without penalties or taxes?
You can simply leave the money with your former employer’s plan. There is no requirement to move it. If you are happy with the plan’s investment choices, the fees are low, and your money is making decent growth, then leave it alone. If you retire from a company at age 55 or older you can access the money without the 10% penalty. You can also borrow from it. If you roll it into an Individual Retirement Account (IRA), you have to wait until age 59 ½ for the money to be penalty free.
Another way is to roll it to an IRA of your choice. It remains tax deferred, meaning there are no taxes until you withdraw the money during retirement. Most often you will have more investment options in your personal IRA than in your former employer’s account. If you choose this option, it’s most important to do a direct transfer by contacting your former employer’s plan administrator. They will handle the transfer into the new account.
Do NOT ask for a check made out directly to you. This will trigger an automatic 20% deduction for federal taxes. You may also be tempted to use the money for other things and this would be detrimental to your retirement goal. As mentioned above there is also the 10% penalty if you withdraw the money before age 59 ½. If you do withdraw the money in your name you have only 60 days to deposit it into an IRA or it will be considered a lump sum distribution subject to taxes.
Your third option is to roll the money into your new employer's account. Not sure how good their plan is? Then check out Brightscope.com for the ratings.
Regardless of which option you choose, one can’t express enough the importance of not removing any money from an IRA before actual retirement. If you do so before age 59 ½ you will lose 40% of your withdrawal due to penalties and taxes.
Unfortunately, statistics show that when rolling money over to an IRA, one out of three employees dip into their cash. This is especially true for those in their 20’s and 30’s who do not understand the importance of compound interest. This is when interest is added to the principal of an account and from that point forward the interest earns interest. This is different from simple interest where interest accrues only on the original principal.
For instance, if you had $10,000 in your account and it grew at 10% annually, after one year you would have $11,000. If it grew again the second year at 10%, you would now have $12,100 ($11,000 X .10). So your interest grows interest. The longer your account remains untouched the more it compounds.