When To Choose a 401K Rollover and Why

An employee must choose a 401k rollover if he would like to avoid the need to maintain and manage multiple 401k accounts as well as pay extra due to the account charges towards administration of all these accounts. By doing this, the account owner can continue to achieve decades of tax-deferred compounding that his invested funds earn in a 401k account.

A major benefit of a 401k-retirement plan is that the employee has an option to keep it throughout his career. When changing a job or employer, the investor can select one of the four alternatives:

  1. Leave the funds in the old employer’s 401k plan – An employee can choose to leave his funds in the old employer’s 401k plan by administration fees and other charges to the account administrator to manage the account. The current employment of an employee does not affect continuing the 401k account with a previous employer. Some employers, however, require a certain minimum amount in the account be met to continue a former employee’s 401k account. If the minimum is not met, the former employee has to either roll the funds over to the new employer’s 401k or an IRA or withdraw the funds. If the employee has switched jobs several times over, it can lead to multiple 401k accounts leading to complexity in managing them as well as incurring their separate management fee by the employee.
  2. Do a 401k rollover to the new employer’s 401k plan – An employee can avoid from having to look after multiple 401k accounts by choosing to rollover to the new employer’s 401k plan. This becomes possible if the employee gets a new job offer before leaving his current employer. Choosing this option tends to simplify things for an employee. However, before going for a rollover, the account owner must check the investment options of the new 401k-plan into which he is rolling over his previous account. The employee can even choose to rollover into an IRA account.
  3. Do a 401k rollover into an Individual Retirement Account (IRA) – Choosing to rollover a 401k account is considered the best alternative for those employees who are interested in building up a comfortable retirement fund as it allows an employee’s savings to continue compounding tax-deferred while providing total control at the same time over asset allocation. This is how a rollover is undertaken: The account owner orders a distribution of his current 401k plan assets (this is reported in the IRS Form 1099-R.) After receiving his assets, the account owner must put them into a new retirement plan within a span of sixty days; such a deposit must be reported in the IRS Form 5498. An account owner cannot have more than one 401k rollover within a span of twelve months.
  4. Withdraw the funds, pay a 10% penalty fee as well as the taxes on amount withdrawn – If an employee decides to withdraw the proceeds, he has to pay a 10% penalty on a disincentive for undertaking a withdrawal. Moreover, the proceeds invite regular income tax rates. This makes the withdrawal process much more expensive to the account owner. It is deliberately designed in such a manner to discourage employees from using up their 401k funds before the age of retirement. In this particular situation, the financial loss comes from the decades of tax-deferred compounding that the invested funds would have earned had the account owner not chosen to withdraw the proceeds.

Always consult a financial professional before you make any decisions.

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