The 401(k) is one of the most valuable retirement planning vehicles around. As traditional pensions become rarer and rarer, more and more employees are being asked to play an active role in planning for their life after work. One of the most difficult parts of this retirement planning comes when employees change jobs.
Changing jobs is always an exciting experience. Whether you have found a job with higher pay, better benefits, more responsibility or just a better location, a new job can be a great thing. What is not a great thing, however, is losing part of the 401(k) you have worked so hard for to taxes and penalties. If you do not handle your 401(k) transfer properly, you could end up with a big tax bill, and a much smaller nest egg for retirement.
Perhaps the most important thing to know about handling a 401(k) transfer is that in order to avoid taxes and penalties the funds must never pass through your hands. The transfer must be made directly from your current employer to your new one. The funds contained in the 401(k) must be transferred directly from the current custodian to the new one.
The human resources department at your current employer, as well as the human resources director who hired you for your new position, will be able to assist you with the paperwork required to complete this transaction.
There are several ways to go about transferring the funds in a 401(k) program. One option is to simply leave the money where it is. Not all employers will allow those who no longer work for them to leave their funds in the company’s 401(k), but some will. So if you like the mix of investments and the performance of your current 401(k), you may want to consider this option if it is available.
The downside to this approach, of course, is that you may lose track of the funds and their performance after you have moved on. It is harder to track the performance of a 401(k) when you no longer work for the company, and you may find that you do not receive all pertinent statements and announcements about the plan.
If your new employer has a 401(k) plan, you will probably have the option to move the funds from your current plan to the one. Even those companies that require a waiting period for participation in their 401(k) generally will allow the funds to be transferred immediately upon your start date.
The other option is to roll the proceeds of the 401(k) plan into a self-directed IRA account. If you have an IRA account at a brokerage or mutual fund, they will be able to help you with the paperwork to affect such a transfer. If you do not currently have an IRA, your bank, brokerage or favorite mutual fund will be able to help you transfer your 401(k) funds in a way that will no trigger taxes or penalties.
Anytime you are changing jobs, or between jobs, there is a strong temptation to get at the money in the 401(k) fund. After all, for many people, their 401(k) is their biggest single investment asset, and it can certainly be tempting to use that money for daily expenses, or to pay off accumulated debt. Before doing so, however, consider that there are considerable tax and penalty implications for such a move. Not only will most premature 401(k) withdrawals trigger a 20% penalty, but the funds withdrawn will be subject to regular taxation as well. It is rarely a good idea to pull funds from a 401(k) when changing jobs, so be sure that the money in the fund goes directly from one retirement savings plan to another.