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Rolling Over Your 401(k) - Quitting or Leaving

When you leave your job which is officially called terminating employment, you can take your money out of your 401(k) and put it somewhere else. This must be done properly or it can result in huge tax consequences. The choices made are almost always irrevocable. Do not do anything without a professional's help unless you know exactly what you are doing.

The term "rolling over" is generically overused. Technically, "rolling" refers to a specific method of transferring your 401(k) account to a new qualified account.

A Qualified Account is any account which "qualifies" for special tax treatment. For our purposes here a qualified account will be a 401(k), a 403(b), or one of the several kinds of IRA accounts. Each type of account has its own rules which you must understand.

To roll over your 401(k) account you get a check from your company payable to you. You then have 60 days to get that money into another qualified account or it counts as a distribution and the taxes come avalanching down. Avoid this if you can.

What a lot of people call a roll over is actually a trustee to trustee transfer.

A Trustee is simply a company that services your IRA account. A trustee has certain duties and responsibilities. Any company that will allow you to open an IRA account is a trustee. Any 401(k) plan that you transfer to has a trustee. When you see the word trustee, just think IRA company or 401(k) company.

In this process the balance of your 401k account is paid directly into your new account. This can happen electronically or there can be a check involved. If there is a check the check will be made out to your new company, not to you.

It should say something like:

Pay to: New IRA account company, FBO Bob Smith

FBO means "For Benefit Of"

This is the part that so many people mess up. Do not call or fill out a form before talking with a professional. If you hear the words "Who do you want the check made out to" this is the red flag. Do not have the check made out to you!

If you transfer the whole balance from your 401(k) to another 401(k) or an IRA there are no taxes and everything is fine.

Remember you cannot rollover before you pay off your 401(k) loan, otherwise the loan will be considered a distribution from your 401(k) plan subject to ordinary income taxes and a 10 percent penalty if you are under age 59 1/2.


Should You Transfer Your 401(k) Or Leave It

In general you should transfer your 401(k). You might know all the right people and all the right phone numbers now, but what about in ten years? I have had dozens of clients who told me that they had a 401(k) at Company X but they don't have a statement. In fact, now that I mention it they haven't gotten a statement for years, usually because they forgot to change their address with them. (They meant to, but they kept forgetting it, and when the mail stopped forwarding, they just lost track. Don't get me started on the identity theft goldmine your 401k statement represents for the people who live in your old house, or the people that go through their recycle bins.)

In addition to being a recipe for neglect, the fact of the matter is that inside your 401(k) plan you have a limited number of investment choices that were picked by someone else. Sometimes that someone else is a competent person who puts a lot of thought and effort into the selections. Other times, that person is a very busy HR Director who ends up just taking the recommendations of the person who sold the 401(k) plan to them. This is how you end up with these crappy fund choices that were "hot" a year or two ago but have terrible long-term records.