Don’t cash out your retirement plan if your employment status changes. If you do, you may owe federal income tax and a penalty. Instead, you may be able to leave the money in your former employer’s plan or set up a direct rollover to your new employers’ plan or an IRA.
As you consider your options, keep in mind that one of the greatest advantages of a 401(k) plan is that it allows you to save for retirement on a tax-deferred (or in the case of Roth accounts, potentially tax-free) basis. When changing jobs, it's essential to consider the continued tax-deferral of these retirement funds, and, if possible, to avoid current taxes and penalties that can eat into the amount of money you've saved.
Leave the funds where they are
One option when you change jobs is simply to leave the funds in your old employer's 401(k) plan where they will continue to grow tax deferred.
However, you may not always have this opportunity. If your vested 401(k) balance is $5,000 or less, your employer can require you to take your money out of the plan when you leave the company. (Your vested 401(k) balance consists of anything you've contributed to the plan, any employer contributions you have the right to receive, and any investment earnings on these contributions.) Your employer may also require that you withdraw your funds once you reach the plan's normal retirement age.
Leaving your money in your old employer's 401(k) plan may be a good idea if you're happy with the investment alternatives offered or you need time to explore other options. You may also want to leave the funds where they are temporarily if your new employer offers a 401(k) plan but requires new employees to work for the company for a certain length of time before allowing them to participate. When the waiting period is up, you can have the plan administrator of your old employer's 401(k) transfer your funds to your new employer's 401(k) (assuming the new plan accepts rollover contributions).
Transfer the funds directly to your new employer's retirement plan or to an IRA (a direct rollover)
Just as you can always withdraw the funds from your 401(k) when you leave your job, you can always roll over your 401(k) funds to your new employer's retirement plan if the new plan allows it. You can also roll over your funds to a traditional IRA. You can either transfer the funds to a traditional IRA that you already have or open a new IRA to receive the funds. There's no dollar limit on how much 401(k) money you can transfer to an IRA.
You can also roll over ("convert") your non-Roth 401(k) money to a Roth IRA. The taxable portion of your distribution from the 401(k) plan will be included in your income at the time of the rollover.
If you've made Roth contributions to your 401(k) plan you can only roll those funds over into another Roth 401(k) plan or Roth 403(b) plan (if your new employer's plan accepts rollovers) or to a Roth IRA.
Generally, the best way to roll over funds is to have your 401(k) plan directly transfer your funds to your new employer's retirement plan or to an IRA you've established. A direct rollover is simply a transfer of assets from the trustee or custodian of one retirement savings plan to the trustee or custodian of another (a "trustee-to-trustee transfer"). It's a seamless process that allows your retirement savings to remain tax deferred without interruption. Once you fill out the necessary paperwork, your 401(k) funds move directly to your new employer's retirement plan or to your IRA; the money never passes through your hands. And, if you directly roll over your 401(k) funds following federal rollover rules, no federal income tax will be withheld.
Note: In some cases, your old plan may mail you a check made payable to the trustee or custodian of your employer-sponsored retirement plan or IRA. If that happens, don't be concerned. This is still considered to be a direct rollover. Bring or mail the check to the institution acting as trustee or custodian of your retirement plan or IRA.
Earlier access to penalty-free funds
Tapping an IRA early can be cumbersome and expensive. You basically have two choices: Take the amount you want and, if you’re under age 59½, pay a 10 percent penalty plus income tax on the withdrawal. Or, set up a 72(t) distribution, which mandates regular withdrawals for at least five years, but limits the amounts to a tiny slice of your savings.
But if you are laid off or take early retirement at age 55 or after, you can tap your 401(k) without penalty, but that only applies to company plans.
Permissible Rollovers
Rollovers between retirement plans are generally permitted for most plans. Some common examples include:
· IRA to IRA — Except for the one-year rule above, you can roll over one IRA to another as you see fit.
· IRA to 401(k) — This one takes a lot of people by surprise. You can perform this rollover as long as the new employer 401(k) plan allows it. You are also restricted to rolling over only the tax-deductible portion of your IRA plan. Any amounts not tax-deductible cannot be rolled over into a 401(k) plan. Depending upon the terms of the new 401(k) plan, a rollover can be considerably more complicated. You have to check with the new plan trustee to determine specifically what those terms will be and what you’ll need to do.
· 401(k) to an IRA — This is probably the most common type of rollover. It’s so common, in fact, most plans are able to make it happen with relatively little effort on your part. The most common reason for a 401(k)-to-IRA rollover happens when you leave an employer where you have a 401(k) plan. You may do this several times in your career, and most people will roll the funds over into an IRA.
· 401(k) to another 401(k) — This is permissible as long as the plan with the new employer allows it. If it does, there may additional rules specific to the new plan.
· 401(k) or Traditional IRA to a Roth IRA — Due to the potential tax consequences of converting tax-sheltered retirement savings to a Roth IRA, this is a separate discussion we won’t spend time on here. You can get information on rollovers to a Roth IRA on this https://investorjunkie.com/26132/rollover-401k/
Whatever type of retirement plan rollover you’re attempting to do, be sure you follow proper procedures which will allow you to do it without suffering any tax consequences and fees.
The Mechanics of a Successful Rollover
No matter what type of retirement plan rollover you’re trying to do, the basic methodology is about the same. Whatever type of rollover you’re trying to perform, be prepared to do the following:
· Step 1: Set up your IRA account before beginning the transfer — If you receive the distribution from your old plan, then go out looking for a home for it, you will risk mistakes which could possibly lead to tax consequences.
· Step 2: Contact the current plan administrator — Administrators typically have set procedures on handling rollovers. Let them know you want to do a direct rollover of your old plan into the new one. This will enable you to avoid withholding taxes on the distribution.
· Step 3: Make sure the check is made out to the new plan trustee — If the transfer check is made payable to you personally (which is an indirect transfer) the trustee on the old plan will have to withhold income taxes. This will reduce the amount of the rollover, and subject you to actual taxes — plus the 10% additional tax on early withdrawals — on the amount of the withholding.
· Step 4: Deposit the check within 60 days — Better yet, deposit it immediately so you don’t forget about it. If the funds are not deposited within the 60 day window, it will be considered a regular distribution, subject not only to income taxes, but also the 10% penalty if you are under age 59 ½.
· Step 5: Report the rollover on your income taxes — This is actually a simple affair as long as there is no tax liability on the distribution (and there won’t be if you handle the transfer correctly). Your old plan trustee will issue you an IRS Form 1099-R, reporting the amount of the rollover. It will also indicate it is a non-taxable distribution.
If you’re ever in doubt as to how to properly structure your retirement rollover, consult with both the old plan trustee and the new one. The rules for a rollover are very specific, and both trustees will have an established protocol that should make the rollover a stress-free affair.
For more information, check out the IRS website for more specific requirements on :
Sources:
https://investorjunkie.com/34465/properly-rollover-ira-401k/
https://www.bankrate.com/retirement/6-reasons-not-to-roll-over-your-401k/#slide=1