If you decide to quit the firm that manages your 401(k), you have four choices for how to handle your assets. The tax repercussions vary depending on the option you choose. The requirements are different if you borrowed from your 401(k) and then quit your employment before returning the debt.
- You may keep your money in the 401(k), but you will no longer be able to contribute to it.
- You may move your money to your new company’s 401(k), but not all 401(k)s allow such transfers.
- You may move the cash to a rollover IRA, but make sure you perform a direct rollover to avoid paying taxes on it.
- You may cash out your 401(k), but you may be charged an early withdrawal penalty and must pay taxes on the whole amount.
1. Leave the Money Alone
Will You Owe Taxes? No
There are no significant tax consequences to keeping your 401(k) savings in your previous employer’s plan. Your money will grow tax-free until you remove it.
If your account value is relatively modest (less than $5,000), the plan is not compelled to let you remain, but the business that administers the plan assets often permits members to roll the 401(k) plan assets into a similar IRA that it provides.
You will, however, be unable to make further payments to the plan. Furthermore, since you are no longer a participant in an employee plan, you may not get critical information regarding major changes to the plan or its investment options.
Furthermore, if you choose to keep your money in your previous plan and then try to relocate them later, it may be difficult to convince your prior employer to release the funds in a timely way.
2. Move the Money to a New 401(k) Plan
Will You Owe Taxes? Not if You Do it Right
If you roll your 401(k) into a plan offered by your new company, you will not have to pay taxes on it. However, before committing to the new plan, be sure you like the investing alternatives and that you understand the expenses involved.
One caveat: While 401(k) money may be moved from one plan to another, plans are not compelled to accept transfers. Your ability to pursue this option is determined by the plan terms of your new workplace. Furthermore, if the new plan is not a 401(k), things might become complicated since not all defined-contribution plans are permitted to take 401(k) assets.
One benefit of this option for older workers is that you are not forced to draw required minimum distributions (RMDs) from your current employer’s 401(k). Transferring 401(k) funds from a former job to your new work deposits the funds from the previous employer into the non-RMD current company’s 401(k) pot. You will not have to take RMDs on any of that money until you retire.
3. Establish a Rollover IRA
Will You Owe Taxes? Probably No (If You Take a Direct Rollover)
If you are unable to move to another employer-sponsored plan or do not like the fund selections in the new 401(k), creating a rollover IRA for the money is an option. You may send any amount, and your money will grow tax-free.
However, it is critical to establish a straight rollover from plan to plan. If you gain possession of your 401(k) assets via an indirect rollover, in which the money goes through your hands before entering the IRA, your prior employer is obligated to withhold 20% for federal income tax reasons, as well as perhaps state taxes.
4. Cash Out and Take a Distribution
Will You Owe Taxes? Probably Yes
Distributions from your 401(k) will be taxed at your current tax rate (k).Furthermore, if you are under the age of 5912, your distribution will be deemed premature, and you will be penalized 10% for taking it too soon.
If you have an outstanding 401(k) loan, you must return it within a particular time limit or the amount would be considered a distribution for tax reasons.
If You Have Taken a Loan
If you have an existing 401(k) loan, regardless of which of the above alternatives you choose when you leave your employment, any outstanding 401(k) loan amounts must be returned, generally by the deadline for filing extended tax returns in October of the following year.
If you do not return the money, the IRS considers it an early withdrawal, and you must pay taxes on it in addition to the early withdrawal penalty if you are under the age of 5912.
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