By Steve Zeller
Changing jobs? Don’t forget about your 401(k) plan - know your options
Changing jobs can be stressful. You have to get used to new responsibilities and new surroundings. One of the last things on your mind is what to do with your 401(k) from your previous employer. But improper handling of your 401(k) distribution can be a costly mistake.
You generally have two options for handling your 401(k) funds once you switch jobs:
You may continue to defer paying taxes on the money by rolling over all or part of it (not all plans allow for partial rollovers) directly into a traditional Individual Retirement Account or qualified plan.*
You may take possession of all or part of your account balance. You will pay federal taxes and state taxes, if applicable, and perhaps a 10 percent penalty tax, on the amount you don’t roll over. (The plan could have restrictions on the frequency that distributions can be made).
A rollover occurs when you distribute the funds from your 401(k) retirement plan, tax-sheltered annuity or IRA and deposit the proceeds into another qualified plan or IRA. The amount “rolled over” is not included in your gross taxable income for the current year and does not increase your tax liability for that year.
With a direct rollover transfer, your employer sends the amount of your 401(k) account balance directly to your choice of financial institution or other plan custodian, such as your new employer’s retirement plan.* Your employer is not required to withhold any federal income taxes with this option.
If you choose an indirect rollover, your employer pays your 401(k) account money directly to you. You then have 60 days to deposit all or part of these assets in your traditional IRA to continue the benefits of tax deferral. If your employer pays your retirement account balance directly to you, your employer is required by law to withhold 20 percent of your distribution for federal income taxes. The intent of the law is to encourage you not to keep your account assets, but rather to roll over the funds into a retirement account to keep them working for your retirement.
The 20 percent withholding works like this: Let’s assume your 401(k) plan balance is $100,000. If you choose to receive that money, rather than having it directly rolled over, your employer must withhold $20,000 (20 percent of $100,000) and distribute the remaining $80,000 to you.
You would still have 60 days to roll over the funds to continue deferring taxes, but to complete a full rollover, you would have to deposit the original amount of $100,000. Since only $80,000 was paid to you, you would have to come up with $20,000 more from other funds.
If you don’t deposit the entire $100,000, the $20,000 that was withheld will be taxed. If you can afford to replace the $20,000 with other funds, you won’t owe any additional tax on the distribution. In the meantime you’ve temporarily lost the use of the replacement funds. Keep in mind that withdrawals before 591/2 may be subject to a 10 percent IRS penalty.
And remember, when you switch jobs, if you do not want to be limited by the investments offered in your new employers plan, you can always roll over your previous retirement funds into a traditional IRA. Your financial consultant can help you determine the best plan.
* The new employer plan must allow for rollover contributions.
Zeller is a financial consultant with A.G. Edwards & Sons., Inc., member SIPC, 379 Lytton Ave., Palo Alto 94301. For more information, call 326-5010 .
