Retirement

Why You Should Rollover Your Old 401(k) Directly to a New 401(k)

5353181348 791941d5f4 z Why You Should Rollover Your Old 401(k) Directly to a New 401(k)

Have you found a new job? Are you starting a new career? What are you going to do with the 401(k) retirement plan that you left in the care of your previous employer? Here’s what you should do: rollover your old 401(k) retirement plan into your new employer’s plan right away.

Here are a couple reasons why you should not let your old 401(k) sit idle for long.

Keeps You Out Of the Cross Hairs of the IRS

The people at the Internal Revenue Service (IRS) are sticklers about the rules for a retirement plan rollover. You can withdraw the money in your 401(k) plan, but that is almost always a horrible idea. You will forgo future earnings on that money. You will also most likely have to pay taxes and a penalty.

Because a 401(k) plan is tax deferred, you will owe federal and state income tax on the amount of money that you withdraw. This will count as ordinary income and can push you up into the next tax bracket if you are not careful. Also, if you are under 59½ years old, you typically have to pay a 10% penalty for a premature distribution. Between the taxes and the penalty, this can be a significant chunk out of your retirement savings.

You could have your fund manager send you a distribution check directly which will be made out to you. Then, you will have to deposit the funds in your new employer’s 401(k) retirement plan. Or, you can conduct an indirect rollover into an IRA of your choosing. But, both of these options are very dangerous. You only have 60 days to deposit the funds, or the IRS will consider it a premature distribution.

Save yourself the headache and have your old 401(k) plan manager directly rollover your old 401(k) into your new employer’s plan. There will then be no penalties, no taxes until you withdraw the money in retirement, and no temptation to hold it out longer than 60 days.

Keeps You Continuing to Invest for Retirement

Rolling over your 401(k) directly from your previous employer to your new one keeps you investing. There is something to to be said for inertia. It is powerful. Because once you stop investing, it can be a nightmare for many to find the motivation to start back up again. You’re already doing it – just continue.

Another thing to keep in mind is that you cannot invest in your previous employer’s 401(k) plan when you do not work there anymore. This is incentive to find a new plan or a traditional IRA to roll your 401(k) over to right away. You are losing the power of compounding interest and missing investing opportunities if you are just sitting on the sidelines.

401(k) plans provide a relatively cheap and an easy way to invest for retirement. Historically, most 401(k) plans and especially those who mirror the markets with index funds have low expenses. You should continue to take advantage of these great retirement investment vehicles even when you switch jobs. You should look to rollover your old 401(k) plan to your new employer’s plan as soon as possible. And, be extremely careful taking any direct distributions from your plan even if you have the best intentions at heart.

Photo Credit:  Anitah

About Hank Coleman

Hank Coleman is a finance writer, financial planner, and self-proclaimed investing junkie. He has a Masters Degree in Finance and a Graduate Certificate in Financial Planning. Be sure to follow him on Twitter @MoneyQandA and on his blog, Money Q&A

Subscribe to our Newsletter