401K Transfer

A 401K transfer can be done under a limited number of circumstances, but there are a lot of rules that need to be considered to keep your savings safe.

You're only offered the opportunity to move your account immediately after you leave a job, often within 30 days, or when you turn 59 years and 6 months old, or when you retire.

When you leave your job you have four options about what to do with your account. You can leave the money in your former employers plan, you can roll it into a plan with your new employer, or roll it into an IRA (independent retirement account), or you can cash out.

When you do a 401K transfer to a new employer you need to be very careful about how you fill out the paperwork. You are responsible for this paperwork, and if filled out incorrectly it can be seen as cashing out by the IRS, and then you have to pay penalties I'll describe later. When you fill out a 401K election form you want to be clear about wanting a trustee to trustee transfer. What this means is that you want the funds to go directly to the new account, not come in a check to you. Even if you take this check and put the money into the account yourself, you risk this being seen as a cash out by the government. Also, if a check comes to you, your former employer is required by law to hold 20% of the account to pay the taxes on the account. You will have many problems if this happens, so make sure that it is clear you want the funds directly transferred.

When you decide to do a 401K transfer to an IRA instead you still want to make sure the funds go directly to the IRA instead of to you. The only real difference here is that you are more in charge of the account, and need to find a company to open an IRA at yourself. You'll want to make sure that you are doing a rollover to a traditional IRA instead of a roth because traditional accounts take pretax funds, like the money from your 401K, where as roth accounts are after tax.

When you choose to cash out an account early you are charged a heavy penalty. If you cash out instead of doing a 401K transfer you are charged federal and state taxes on the amount taken out of the account, plus a ten percent early withdrawal fee. The federal tax percentage is determined by your tax bracket, which you can estimate based on your tax papers from last year, and state taxes are determined by the state you are filing in. The total penalty is therefore different for everyone, but the percentage could easily be 30% to 40%, plus the money the account would have accumulated for you up until you reached retirement age. That's a lot of money to miss out on, so people generally don't do this unless they feel they have no other choice. This is why it's so important you are clear about your wishes on your 401K transfer papers.