you leave your current job, you will have to most likely fill out
401(k) distribution election form. The most logical thing to
do with your 401(k) from a taxation perspective is to do a direct
rollover (also known as a trustee-to-trustee transfer) of your money.
With this type of rollover, the money goes directly from your 401k
plan into another tax-deferred account, either an Individual Retirement
Account (IRA) or your new employer’s 401(k) plan, 403(b) plan
or 457 plan. 403(b) plans are generally for teachers, educators
and non-profit employees while 457 plans are offered by local state
governments. With a direct 401k rollover, you do not have to pay
any taxes on the money when it comes out of your old employer’s
401(k). The money will also continue to grow tax-deferred in the
new account. In other cases, instead of transferring the money directly
to the new 401k plan or IRA, your employer might give you a check
for the 401(k) balance.
Rollover 401k Video -
Options Available for a 401k Rollover to an IRA or Rollover to New
This video explained by a pretty lady shows you the options you
have when you are changing jobs when you can either take your money
with you and roll it over to an IRA, or rollover to your new employer's
With a direct rollover, the check will
be made out to the financial institution that holds and maintains
your account. We advise NOT to instruct your old employer to make
the check out in your name, as the tax consequences and penalties
for doing this are severe! Here’s how. If the check is made
payable to you, your former employer will be required to withhold
20% of your account value as federal withholding tax.
an example, if you have $100,000 in your 401(k) that is
made payable to you in a check, your employer will withhold
$20,000 for remittance to the government. Thus, in order
to bring your balance up to $100,000 in your new account,
you will have to pay from your own pocket, an additional
$20,000 within 60 days of receiving the distribution. The
IRS will then return the $20,000 owed to you when you file
your tax return upon correct completion of your rollover.
Note: The IRS
is very strict on this 60 day distribution rule and there are no
The size of your 401(k) account also matters.
For instance, if your account balance is less than $5,000, you may
be forced to take the money out of your employer’s 401(k)
plan when you quit or leave. If it’s more than $1000 and less
than $5,000, and you don’t tell your employer what you want
to do with the money, your employer can automatically roll the money
in to an IRA on your behalf. If the balance is $1000 or less, your
employer will simply issue you a check for this full amount. You
should let your employer know right away that you want to do a rollover
if your balance is less than $1,000.
If your 401(k) account balance is $5,000
or more, and you have not reached your normal retirement age (65),
your employer is required to let you leave your money in the 401(k)
plan if you choose to. This might be a good temporary choice, but
you have to make a permanent decision.
Rollover 401k Video -
IRA Rollover and its Pros and Cons
This video by Christy Lee who is a licensed stockbroker gives you
a run down on the options you have when you rollover to an IRA from
your old employer's 401k.
Rolling to a Traditional IRA
If you choose to rollover your 401(k) account
to a traditional
IRA, you can make two types of contributions, i) a deductible
contribution where you can deduct from your income tax and ii) a
non-deductible contribution where you can’t deduct your contributions
from your income tax. The advantage of rolling to a deductible traditional
IRA is that you can deduct your contributions from your income tax
now. However, if you rollover to a non-deductible traditional IRA,
you will not be able to deduct your contributions from your income
tax now. However, there is always a reverse side. With a deductible
IRA, you will have to pay income tax when you withdraw the funds
upon retirement, typically at the age of 65.
The deductible IRA seems like a better
deal because you can get an extra tax break of being able to deduct
your contributions from your income tax. However, there is a catch
here. The catch is that if you have a 401(k) or any other employer
sponsored tax-qualified plan, you can deduct contributions to your
traditional IRA only if your income is below the Modified Adjusted
Gross Income (MAGI) limits.
Adjusted Gross Income (MAGI) Income Limits for Deductible
Contributions to a Traditional IRA