Via LearnVest By Libby Kane ~
When you leave a job, you may leave behind your stapler and your computer … but in most cases, you shouldn’t leave your 401(k).
Since it doesn’t exactly fit into a cardboard box, bringing your company-sponsored retirement fund with you is a little more complicated. The process is called a “rollover,” and it means moving money from one retirement account into another.
How do you do this? And why should you bother?
What Are My 401(k) Rollover Options?
As we know, a 401(k) is a company-sponsored retirement fund that your employer provides, and your 401(k) contributions are automatically withdrawn from your paycheck before it hits your bank account. Sometimes companies will also provide a company match, which means that if you contribute to your account, they’ll pitch in some money to give you an added incentive to save.
When you’re leaving a company, you have four options for your 401(k):
- “Cash out” or withdraw the money from the account (not a good plan)
- Roll the money over into an IRA (individual retirement account, which isn’t employer-sponsored)
- Roll the money over into a new 401(k)
- Leave the money in that account
Why You Shouldn’t Cash Out
A 401(k) is a retirement fund, so if you withdraw funds before the age of 59 ½, you’ll pay an early withdrawal penalty and the funds will be taxed as regular income. The penalty is 10%, plus taxes on any investment gains. If you cash out, not only will your money stop growing, but you’ll end up with less money after paying all of the taxes and fees.
Also, while the nature of the stock market means that no one can guarantee investment growth, it stands to reason that a larger fund would earn you more investment gains over a long time horizon.
For example, imagine that you had a 401(k) totaling $10,000 in funds when you leave your job at Alpha Corp for another opportunity at Beta Corp. You “cash out” your 401(k) when you leave Alpha. A few years later, you have a 401(k) with Beta Corp of $20,000, which earns a 7% annual return on its investments ($1,400) after 12 months.* Had you rolled the $10,000 from your Alpha fund into the Beta fund, bringing your total to $30,000, you’d have earned $2,100 in investment gains in the same 12-month period. While that may not seem like a big difference, five years later, assuming that the fund continued to earn 7% a year, the account that started with $30,000 would have about $3,500 more than the account that started with $20,000.
When You Should Roll Over Your Old 401(k) Into a New 401(k)
Mistakenly, some people think that the money from their 401(k) has to stay with the company that established the account. In fact, you’re allowed to take it with you by converting or “rolling over” that money into a 401(k) at your new place of employment (or into an IRA, the benefits of which are described below).
By rolling over your old 401(k) into your current account, and consolidating these accounts, it means that you only need to monitor the activity for one account, rather than track multiple retirement accounts from different stages in your life. If you don’t have a new 401(k), you can also consolidate accounts by rolling the money into an IRA.
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