Rollover – Not in Your Bed, But to a Roth IRA

With less than three weeks of work left, my calendar is quickly filling up with farewell lunches.  I have not, however, neglected other more important things related to my departure, such as making sure I will get paid for unused vacation days and that my calculation is the same as HR’s.  ALSO, I have been researching on what to do with my 401k once I leave, and below is a list of dos and don’ts.

  1. Do not withdraw  – Apparently one of the biggest mistakes that people make when they leave a job is to withdraw the money from their 401k.  Not only will you be making a HUGE dent to your retirement funds, you will be paying heavily for it – income tax for the distribution plus an additional 10% tax  (the IRS says tax, I say penalty) for withdrawing before you hit the magic age of 59 1/2.
  2. Do not just leave it in its current account – Now is the time to assess how well the account has been growing.  Do you like the investment options offered by your company and the investment company they have selected?  Are you satisfied with the services?  If not, you are free to take your business elsewhere, whether to one you select individually or another 401k account offered by your new job.
  3. Do roll it over – If you do decide to transfer your 401k to a new account, do a rollover.  Once a check gets cut to you – even if you deposit it directly into a new retirement account – the IRS will consider that a withdrawal and you’ll be hit with the income tax and the 10% penalty.  It’s better to play it safe and arrange for a direct transfer, so that no money passes through your hands.
  4. Do consider a Roth IRA – As mentioned in previous posts, you contribute post-tax dollars to a Roth IRA but it then grows tax-free.  This is what I plan to do with my 401k account.  And while I’ll get hit with taxes in the beginning (because I contributed only pre-tax dollars to my 401k initially and Uncle Sam always gets his cut), I will never have to pay taxes on any subsequent earnings.  This is crucial, because I expect that I will earn more money as I get older and will be taxed at a higher tax bracket.  So this is not just a matter of paying taxes now vs. paying taxes later, it’s also a matter of paying less taxes now vs. paying more taxes later.  Further, I’m not required to roll over the entire balance at once.  I can control how much I want to roll over each year, so I can spread out my tax burden over several years.
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