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Need to Roll Over Your 401(k)? Follow These Five Steps

You’ve come to a fork in your career path and made a choice, one that means you will soon leave your current job—and the 401(k) that comes with it—in the rearview mirror. Whether you’re moving on to pursue new employment options or making the leap into retirement, take the proper steps to ensure that the savings (and matching funds) that you’ve worked so hard to accumulate come with you. Take the following five steps, and you won’t be one of the 12.5 million people who leave these funds behind annually.
Need to Roll Over Your 401(k)? Follow These Five Steps

1. Don’t withdraw anything (yet).

If you’re under age 59½, keep that money in the 401(k) unless it’s absolutely necessary that you don’t. Cashing out early may seem tempting, but the IRS will hit you with the one-two punch of income tax and an additional 10 percent early-distribution penalty tax.

The hard numbers are striking—if your 401(k) rolls over to an account that brings in 8 percent tax-deferred earnings annually, a $10,000 withdrawal leaves your retirement nest egg down by at least $100,000 over the next 30 years. It could make the difference between rationing your retirement years and relishing them.

2. Be strategic.

If you’re headed into retirement, you will likely move your 401(k) into an IRA. The question is, which IRA? As with all matters of money, the answer depends on a variety of factors, the most important of which involves your tax bracket.

Once you retire and start to draw from your investments, what will happen to your tax rate? If it goes up, consider a Roth IRA, which offers tax-free withdrawals. If it heads downward, you may want to opt for a traditional IRA, which allows you to take the up-front deduction while you’re still employed, setting you up for a lower tax rate after retirement.

If you’re still in the workforce but changing careers, you will typically have three options for managing your 401(k): bring it with you to your new employer, roll it over to an IRA, or keep it as is. There are compelling reasons for each choice that depend on your specific circumstances. With 30 days, by law, to make up your mind, a financial advisor can be a useful sounding board to work out the option that best fits your plans and priorities.

3. Open a new account.

Timing is critical in a 401(k) rollover to prevent unexpected tax consequences. Make sure your new account is in place before giving the all-clear to roll over the funds; otherwise, the IRS will be entitled to a significant portion of it. This is a common request received by plan administrators, and your former employer should be able to deposit directly into the new account either digitally or by check.

4. Roll over directly to your new account.

While it can be tempting to see your 401(k) funds show up in your personal bank account or hold the check in your hand—known as an indirect rollover—beware. Depending on your specific retirement plan, the IRS will take 10-20 percent as a withholding. You then have 60 days to place the funds in a new retirement account, or the IRS will label it as a cash withdrawal and slap it with income tax and other additional penalties.

The smarter option is always to ask for a direct rollover, which transfers the funds directly from your current plan to the new plan’s trustee.

5. Put your money to work.

Now that your funds are safe and sound in their new plan, it’s time to put them to work. Your ideal mix of investment options will change depending on your aversion to risk and current financial needs, but general wisdom suggests that you lean on stocks when saving long term for retirement—then add in cash or bonds to balance out your portfolio.

Focus on maximizing your after-tax returns and don’t be as concerned with the specific tools used to achieve your goals. If it seems daunting, a financial advisor may be a valuable guide to steer you around the curves.

Your 401(k) is one of the most valuable tools in your retirement starter kit. Rolling it over presents the perfect opportunity to look deeply at your career objectives, family needs, tax interests, and how all of these affect your plans for life after work.

A community-focused financial institution will help you achieve these goals as it manages and grows your nest egg. Consider TDECU Wealth Advisors as a partner on this journey.