When deciding whether or not to change jobs, there are numerous things that individual's often consider. There is however an important aspect that most never consider prior to making a job shift. That area of consideration is how they will transfer their 401k retirement savings once they have left their employer. If individuals are not careful, they could potentially loose up to half of their retirement savings by not transferring retirement funds according to government regulations. It is recommended in most cases that an individual choose a company 401k direct rollover to transfer their retirement assets from the employer they are leaving.
It should be noted that there are often options available to leave your assets with your previous employer, however, it is not recommended that you leave retirement funds in the hands of a employer whom you no longer work for. You may also rollover funds into your new employer’s 401k plan but this action is also highly discouraged by most financial advisors. Tony Bass, President and national Financial Wealth Strategist, suggests that you perform a company 401k direct rollover. Your funds can then be distributed into a rollover IRA plan of your choice.
Company 401k direct rollovers allow you to transfer your retirement funds directly over to your new employer's retirement plan or into a rollover IRA plan. With a company 401k direct rollover, a retirement distribution check is directly made payable to your new qualified retirement plan. This transaction can be done on your behalf and allows for the smooth transition of your retirement funds without having to withhold taxes or subjecting your money to potential penalties.
By the contrast, when a company 401k rollover distribution is paid directly to you, it is called an indirect rollover. Law requires that the plan administrator withhold 20% of your funds in an indirect rollover. This money is sent to the Internal Revenue Service as a federal income tax withholding. In addition, you may also be hit with a 10% early withdrawal penalty. This government penalty is designed to discourage you from withdrawing your retirement money early.
To avoid paying the taxes on a company 401k indirect rollover, you must complete two requirements. First, you must invest the entire amount of your distribution funds including the 20% that was originally withheld, into another qualified retirement plan. Secondly, this investment must take place within 60 days of receiving your distribution check. Your 20% withholding can then be filed as a credit on your tax return at the end of that tax year.
Here's an example of how a company 401k indirect rollover would work in the above scenario. Let's say you have a $50,000 401k portfolio account with your previous employer. You perform a company 401k indirect rollover and the plan administrator sends you a check in the amount of $40,000 (20% of your distribution was withheld and sent to the IRS). To avoid the 20% penalty, you must now make a rollover contribution in the amount of $50,000 within 60 days. There could be a potential problem with this scenario because you only received a check in the amount of $40,000. This means you must add an additional $10,000 from your personal funds to avoid being taxed. Provided you fund the entire $50,000 within the 60 day time period, you are allowed to recoup that $10,000 by claiming it as a credit on your income tax return at the end of that tax year.
Worst yet is the scenario of withdrawing your money and not rolling it over into another qualified retirement plan. In the same example, you have a $50,000 401k portfolio account. A check is sent directly to you in the amount of $40,000. Because you never reinvest your money into a retirement plan, at the end of the year you suffer a 10% early withdrawal penalty ($5,000). Next, depending on your tax bracket, there is then an additional 10% federal income tax charge ($5,000) as well as a state income tax charge of let's say 7% ($3,500). With all the taxes and penalties subtracted, your $50,000 retirement savings has been whittled down to $26,500. That equals to almost half of your original retirement investment.
As you can see, it is far better to perform a company 401k direct rollover so that you never have to worry about paying taxes or early withdrawal penalties. Company indirect rollovers can become complicated as well as force you to allocate personal funds that will be tied up until tax filing season. In a worst case scenario, you could end up loosing almost half of your retirement savings by doing nothing after receiving the funds in a check made out to your name. Take the time to consider how you will transfer your company 401k retirement plan prior to making a move. The amount of money you could potentially lose by making the wrong choice could be detrimental. |
