When Should An Employee Choose A 401K Rollover And Why

Posted by Nick Niesen on October 29th, 2010

An employee should select a 401k rollover if he wants to refrain from having to look after and manage multiple 401k accounts and also pay extra in terms of the account charges towards administration of all those accounts. In this way, the account owner can continue to achieve decades of tax-deferred compounding that his invested funds earn in a 401k account. A major advantage of a 401k-retirement plan is that the employee has an option to retain it throughout his career. When changing a job/employer, the investor can choose any of the four alternatives:

1.) Leave the funds in the old employer?s 401k plan ? An employee can choose to leave his funds in the old employer?s 401k plan by paying record keeping and other charges to the account administrator to manage the account. The current employment of an employee does not affect continuing the 401k-account with a previous employer. If the employee has switched jobs several times over, it can lead to multiple 401k accounts leading to complexity in managing them as well as incurring their separate management fee by the employee.

2.) Undertake a 401k rollover to the new employer?s 401k plan ? An employee can refrain from having to look after multiple 401k accounts by choosing to rollover to the new employer?s 401k plan. This becomes possible if the employee gets a new job offer before leaving his current employer. Choosing this option tends to simplify things for an employee. However, before going for a rollover, the account owner must check the investment options of the new 401k-plan into which he is rolling over his previous account. The employee can even choose to rollover into an IRA account.

3.) Undertake a 401k rollover into an Individual Retirement Account (IRA) ? Choosing to rollover a 401k account is considered the best alternative for those employees who are interested in building up a comfortable retirement fund as it allows an employee?s savings to continue compounding tax-deferred while providing total control at the same time over asset allocation. This is how a rollover is undertaken: The account owner orders a distribution of his current 401k plan assets (this is reported in the IRS Form 1099-R.) After receiving his assets, the account owner must put them into a new retirement plan within a span of sixty days; such a deposit must be reported in the IRS Form 5498. An account owner cannot undertake more than one 401k rollover within a span of twelve months.

4.) Withdraw the funds, pay a 10% penalty fee and the taxes on amount withdrawn ? If an employee decides to withdraw the proceeds, he has to pay a 10% penalty on a disincentive for undertaking a withdrawal. Moreover, the proceeds invite regular income tax rates. This makes the withdrawal process all the more expensive to the account owner. It is deliberately designed in such a manner to dissuade employees from using up their 401k funds before the age of retirement. In such a situation, the financial loss comes from the decades of tax-deferred compounding that the invested funds could have earned had the account owner not chosen to withdraw the proceeds.

Always consult a financial professional before making any decisions.