401k Rollover Rules

The 401k retirement plan was created by the United States government in 1978. Before that time the normal way that people saved for retirement was by sticking with a company for a lifetime. When you retired, you got a pension. That seems a quaint notion now.

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        The law was surprisingly good from the start. There have been a few, but not many additions to the 401k structure. One area that needed shoring up was the rollover section. When people switch jobs, as we do so often now, how does the account tag along.

        There are only three main rules for a 401k rollover.
        1. The account can be rolled into another 401k account, a traditional IRA or a Roth IRA or it can stay put.
        2. Any outstanding loans are due within 60 days of the account's transfer.
        3. You can opt to cash out, but cashing out carries a hefty tax fee and a separate fine.

        Let's look at rule number 1. What this means is that you don't have to do anything at all with your 401k. This is good news and bad news. The good news is that the money in the account does not go away. If you have just unexpectedly lost your job, probably the last thing on your mind is saving for retirement. So you can ignore the retirement account for now. All that said, it is really a 5 minute process to send your account to a new home. If you are shifting from one company to another, a quick form is all you need. If you want to put the money into an IRA, you will need to set up your brokerage account first, but that it pretty easy, too.

        Rule number 2: Any loans are due within 60 days. This could be a harsh reality even if you are moving voluntarily to a new job. Did you forget about that loan? Well, yeah when you signed the paperwork for it, it seemed like brilliant finance. Pay yourself back, with interest! Now, if you cannot pay back the loan within the two month time frame, you owe taxes on the entire amount of the loan. I guess there are worse ways to default on a loan.

        Rule number 3: While you always have the option of cashing out your 401k, it is a bad idea. The tax hit is big. You owe taxes, assessed at your current tax bracket, and there is a 10% penalty. When you get out the calculator and run the numbers, you are probably going to end up with about 60% of the retirement money.

        As you can see, the rules are very simple. Save yourself time and money by doing a straightforward rollover 401k. Your future self, the one who can retire at age 68, will thank you!

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