How Do 401k Rollovers Work?

Here's the situation: For one reason or another, you've left your job. Maybe you got a better one. Maybe you started your own business or your position was eliminated. Maybe you just couldn't stand your old workplace and decided to move on. Whatever happened, it was surely a tough decision. But if you had a 401k with that old job, you've got another decision on your hands: How to handle your 401k rollover.

Cashing it out might not be that simple. Sure, you could avoid rolling over your 401k into another investment account altogether, and simply cash it out. And if you really need the money pretty desperately that might be the best strategy. But unless you absolutely need it, you might want to avoid cashing out. All that cash is likely to count as taxable income, and a substantial portion of your 401k's value could be held back for federal taxes. And if you're under 59-and-a-half years old, you might also be assessed a further 10 percent penalty.

Should you keep it where it is? This is a reasonableoption, as it carries no penalty or taxation. But don't get too comfortable: Your 401k may be considerably more difficult to manage when you're no longer with your old employer. You may need to manage it yourself, and your access to the account may be limited.

Should you transfer it to your new employer's plan? This can be a goodoption. Your new employer might have a waiting period, and your investments could need to change to fit your new employer's plan. But this 401k rollover strategy is likely to incur no extra taxes and can be relatively easy to do. Your new employer's human resources department should be able to tell you who to talk to transfer you plan.

Should you transfer it into an IRA? On the whole, this may be your best 401k rollover option. Generally, you won't owe any taxes until you take the money out, you’re likely to  have access to significantly more investment choices than you would have if you had kept your 401k with your old employer Those additional choices can give you the opportunity to structure your holdings so they reflect your unique needs.  You might also be able to combine the funds from the 401k with other retirement monies. A drawback is that you probably won’t be able to take out a loan from an IRA like you can with a 401k, but that's generally not a great idea anyway.

Pay back that loan! If you did take out a 401k loan, you should consider paying it back in full before you quit your job. Most companies will give you a short period of time to repay any outstanding 401k loans once you've left. But if you default, the full amount of the loan generally  becomes taxable income. Of course, the simplest way to avoid this problem is usually to never take out a 401k loan in the first place.

There's time to change your mind. Whatever you do with your 401k rollover, you generally have 60 days to change your mind and adopt a different approach without incurring any penalties.