The 401(k) Demystifier
Enter “401(k)” in any internet search engine and hundreds of thousands of pages will pop up. The sheer volume of advice out there on how much to contribute, what kind of funds to invest in, and how to stay on the right side of the IRS and avoid penalties can be overwhelming. Your company’s plan documents may not be much help either. They’re long, complicated, and filled with legal boilerplate. More often than not, you’ll find that your harried human resources staff doesn’t know much more than you do about complex issues like hardship withdrawals or borrowing against your vested balance.
We’ve put together a list of answers to some frequently asked 401(k) questions that come up when employees leave their current jobs to seek opportunities elsewhere.
1. Can I just leave my money in my old employer’s plan? That’s up to your employer. While many employers will allow you to keep your 401(k) savings invested in their plans after you leave, most employees prefer to move their money into a new account called a Rollover IRA. These accounts typically offer 401(k) investors more investment options than employer-sponsored plans. Once you find a new job, you can usually move the money from your Rollover IRA into your new employer’s 401(k) plan.
2. If I move my money out of my employer’s 401(k) plan, will I incur any fees or penalties? Not if you arrange for a “direct” rollover of funds into a Rollover IRA. It’s a simple process. First, open the Rollover IRA at a custodian like Charles Schwab or Fidelity. Next, tell your former employer that you want to do a direct rollover of your 401(k) assets into an IRA. It’s extremely important that your old employer make out the check to your custodian (on your behalf) and not directly to you. You have 60 days from the day your old employer issues the check to fund your Rollover IRA.
3. What happens if my old employer makes out the check directly to me or I fail to fund my Rollover IRA within the 60-day window? If you are younger than 59 1/2, the IRS considers either of these situations an early withdrawal of assets from your 401(k) account and will assess a 10 percent early-withdrawal penalty. Regardless of your age, the Internal Revenue Code would require your old employer in this situation to withhold 20 percent of your account balance for taxes.
4. Can I contribute new funds to my Rollover IRA? If you want to preserve the option of moving your Rollover IRA funds into a new employer’s 401(k) plan, then you should open a traditional IRA for any additional retirement savings while you’re between jobs. Only funds from a qualified employer-sponsored retirement plan can be rolled into your next employer’s plan. A Rollover IRA, however, is a good vehicle for consolidating several different 401(k) accounts.
5. Can I borrow against my Rollover IRA? Yes. You may withdraw funds from your Rollover IRA tax- and penalty-free as long as you replace the money within 60 days. Note that “Day 1” is the day after you’re in receipt of the check from your custodian, and weekends and holidays count. If you fail to return the funds within 60 days, the IRS will assess taxes and could treat the loan as an early withdrawal. You may only borrow against your Rollover IRA once every 12 months.
Dion Money Management offers managed account services for your IRA, Roth IRA, 401(k) and other retirement accounts. Call one of our Portfolio Strategists at 1-800-432-7447, ext. 191 to learn about the benefits of our managed account program.
