Withdrawing from your 401(k) is one of the most critical decisions you face when changing employment since the incorrect decision may cost you thousands of dollars in taxes and poorer earnings.
Let’s suppose you’ve worked in your present position for five years. Pre-tax earnings from most of those years have been funneled into your 401(k) plan by your employer.
What do you need to do now that you’re out of here? As a general rule, don’t touch it. You have 60 days to make a decision on whether or not to transfer the funds. Don’t give in to the urge to withdraw your winnings. There’s nothing worse than a departing employee withdrawing their 401(k) funds and depositing them directly into their bank account. Why is this so?
Your account administrator will withhold 20% of your total payout for federal income taxes, so if you had $100,000 in your account and wanted to cash it out, you’d be down $80,000.
When it comes time to pay taxes, you’ll have to pay an additional 10% penalty for early withdrawal if you’re younger than 59-1/2. You’ve now dropped to $70,000, a loss of another ten percent.
The exception to 10% early withdrawal tax penalty if you leave employment before or after the year you reach age 55 (age 50 for public safety workers of a state, or political subdivision of a state) Only 401(k) plans are affected by this. The exclusion does not apply to IRA, SEP, SIMPLE IRA, or SARSEP plans.
You’ll also owe the difference between your tax rate and the 20% already deducted at year’s end since distributions are taxed as regular income. You still owe $12,000 if you’re in the 32% tax rate, for example. As a result, you will get $58,000 less in cash in your payout.
But that’s not all! As a result, you may also be responsible for state and local taxes. Taxes and penalties may leave you with less than half of what you had saved up for retirement, putting your funds at risk.
What Other Options Are There?
Before the 60-day transition period expires, you may move your retirement account into the new plan offered by your new employer. “Rollover” is the term for this procedure, which is rather painless. Contact All of the necessary paperwork should be in the possession of your former employer’s 401(k) plan administrator.
Using a direct transfer to move money from one 401(k) to another is the preferred method of transferring retirement savings. There is no need for a check, you avoid all of the taxes and penalties described above, and your funds will continue to grow tax-deferred until you retire.
In order to join in a 401(k), many businesses demand that you have worked for a certain amount of time (k). If this is the case, one option is to wait until the new 401(k) plan is ready before withdrawing your funds. Afterward, you may include it in the new strategy. Most retirement plans allow former workers to keep their assets in the previous plan for a period of time.
Rollover period of 60 days The Internal Revenue Service considers this a cash distribution, if you have your previous employer, make the distribution check payable to you. For federal income tax purposes, 20% of your check will be automatically deducted from your vested amount. In the meanwhile, don’t freak out. Your new employer’s retirement plan or a rollover IRA may receive the lump payment (including the 20%) within 60 days (IRA). In this case, you won’t have to pay extra taxes or the 10% early withdrawal penalty.
If you don’t like your new employer’s investment options, you may want to consider a rollover IRA instead. You’ll be able to pick from a wide variety of funds and get greater control over your finances. Direct rollovers, on the other hand, eliminate the inconvenience of withholding.
Take a Breather
As long as you’ve accumulated more than $5,000 invested in retirement funds, you may generally leave them with your old employer’s 401(k). Until you stop working, the money in your 401(k) will continue to grow tax-free.
Direct rollover into an IRA is your best option if you cannot leave the money in your prior employer’s 401(k) and your new employment does not provide a 401(k). If you’ve made the decision to go into business for yourself, the same rules apply.
IRA withdrawals are taxed as regular income after you’re 59 1/2 years old, and you won’t be penalized for doing so. Age 55 and older are exempt from paying a penalty under the “Rule of 55” of the Internal Revenue Service (IRS).
Even if you aren’t working, you have to start drawing the required minimum distributions (RMDs) from your 401(k) and IRA accounts when you become 72 years old.
You’re Only a Phone Call Away from Help.
If you have any concerns concerning IRA rollovers or need help figuring out how a new job can affect your tax status, please don’t hesitate to call our office.