Whether you have recently been laid off due to downsizing or you’re actively seeking another position outside your current company it is important to have a 401k exit strategy.  When you signed up for a 401k you took the first step toward saving money in a tax-deferred vehicle which you more than likely want to use for retirement.  Unfortunately, 401k plans are not portable (although they should be).  Thus, you’ve got to decide what to do with your old 401k.  Get it wrong, and you could be stuck with massive early withdrawal penalties.  Here are a few tips on how to move your 401k from it’s current location without losing the valuable tax-deferral.

Do Not Cash Out Your 401k!

Unless you’re at least 59 1/2 years old, cashing out will expose you to a 10% early withdrawal penalty in addition to regular income tax (assuming you have a traditional 401k;  if it’s a Roth 401k you’ll just owe the penalty).   These penalties exist to prevent you from sabotaging your own retirement by spending money you’ll need to survive in your golden years.

Rolling Over Your 401k To Another 401k

If your new 401k has stellar investment options (perhaps it’s full of Vanguard funds), you might consider rolling your old 401k over into your new one.  Your new plan’s 401k administrator can help you make the transfer.  Important: Be sure the check is made out directly to your new plan administrator on your behalf and not to you personally.  If it’s not, 20% will be withheld for taxes and you’ll be responsible for fronting than 20% within 60 days lest it be considered a taxable withdrawal by the IRS.

Rolling Over To An IRA

Rolling over to an IRA is by far the best choice for most investors. The advantages of investing in an IRA rather than  401k are threefold…

  1. More Investment Options – You can start an IRA pretty much anywhere you want.  Most of the best mutual fund companies will allow you to buy and sell their funds for free directly from their websites.
  2. Lower Costs - 401k plans are notorious for having all manner of hidden costs.  Running a 401k is expensive for employers, so they often try to pass off a portion of the cost to clueless investors.  In general, investing in an IRA is less costly and since costs matter, that’s a big advantage.
  3. More Convenient – It’s much easier to keep track of your finances when most of your accounts are consolidated in one place.

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