Traditional 401(k). Options are listed in order most preferred to least preferred:
Rollover into IRA- This gives you the most flexibility for your investments. The advantage of rolling over your money to an IRA is that you have control over how the money is invested and have many more investment options. A rollover IRA allows you to transfer money from an employer-sponsored retirement plan without incurring any tax or early withdrawal penalties. You may have to sell some or all of the funds inside the account depending on who you roll the money over to but there will not be any penalties or taxes. Also, you have the option of transferring the money in the rollover IRA to your new employer's retirement plan provided that you do not make any contributions to your rollover IRA.
Rollover into your new company's retirement plan- You are allowed to roll over pre-tax contributions and any earnings in the fund into your new employers tax deferred retirement savings plan. You are not allowed to roll over after-tax contributions. Your new employer may require that you work for them for a specified period of time before you are eligible to contribute or receive matching contributions in their pension plan.
Keep it where it is- If you meet the criteria listed in the retirement plan document, you have the option of keeping your money in the plan. If you decide to leave your money with your former employer, you may not have the flexibility to decide what happens to that money. You may want to consider leaving the money with your former employer if you are happy with the investment vehicles you have selected and you are able to direct how your money is invested. You should consider rolling the money over if the employer limits access or restricts the plan because you are no longer an employee.
Cash out- This is a costly option because of the taxes and penalties incurred, and 45% of people choose this option. Here is why it is a bad idea. There is a 10% penalty for withdrawing money before the age of 591/2 plus payment of ordinary income taxes. Exceptions to the 10% penalty include:
- The employee's death
- The employee's total and permanent disability
- Separation from service in or after the year the employee reached age 55
- Substantially equal periodic payments under section 72(t)
- The distributions were required by a divorce decree or separation agreement
- You paid for medical expenses exceeding 7.5% of your adjusted gross income.
Also remember, that a minimum amount is required to be distributed by April 1 of the year following the year the participant reaches age 70 ½.
Distribution Rules for Roth 401(k)
- 10% penalty plus income taxes on earnings (appreciation above contributions) withdrawals before age 59 1/2. Example: If you contributed $100 into the Roth 401(k) and it grew to $110, you would pay a 10% penalty plus income tax rate on $10.
- No penalty or taxes taken if distribution is after having the account for 5 years and the person is age 59 1/2 or older.
- A minimum amount is required to be distributed by April 1 of the year following the year the participant reaches age 70 ½.
- A withdrawal is taxable in the year received.
- If a participant makes a withdrawal before he or she attains age 59 ½, generally a 10% additional tax applies.
- If this withdrawal occurs within the first 2 years of participation, the 10% tax is increased to 25%.
- SIMPLE IRA contributions and earnings may be rolled over tax-free from one SIMPLE IRA to another.
- A tax-free rollover may also be made from a SIMPLE IRA to an IRA that is not a SIMPLE IRA, but only after 2 years of participation in the SIMPLE IRA plan.