Many people switch jobs multiple times over the course of their lives, oftentimes leaving behind employer-sponsored 401(k) accounts. Determining what to do with these retirement funds can be tricky, as each option comes with its own set of tax implications. In some instances, employees may be tempted to simply cash out their accounts and either put the cash in the bank or spend it. Before doing so, however, it's important to weigh all of the other alternatives to make the most financially suitable decision.
Cashing out is one of the most tempting things to do with an old account. However, most tax preparers and financial advisors discourage individuals from this course of action. Withdrawing the whole of a 401(k) before reaching the age of 59 1/2 will automatically trigger a 10 percent early withdrawal penalty, and the balance will also be subject to ordinary income taxes. In addition to facing these taxes, individuals will miss out on the compounding interest and ability to grow their wealth in a tax-advantaged vehicle if they cash out.
Other 401(k) options
Employees who have switched to a new firm have several alternatives when it comes to managing the 401(k) from a previous employer. For instance, they may choose to roll over their assets into their new company's plan, if allowed. It's important for accountholders to review the type of investment options offered under a new employer's retirement program to ensure they fall in line with their goals. If not, they might also consider rolling their balance into an individual retirement account.
By rolling the funds into an IRA, individuals can still gain the advantages of tax-deferred growth, while also enjoying more autonomy to choose from a broader array of investment options. This may therefore be a good option for those with specific and targeted retirement goals in mind. Those who are considering this option should keep in mind that once they reach age 70 1/2, they will be required to take minimum required distributions from the IRA - with the exception of a Roth IRA - every year, even if they are still working.
Lastly, individuals may also choose to simply leave their 401(k) in the hands of their former employer. However, people should keep in mind that they will no longer be permitted to make contributions and, in some cases, take out a loan. Additionally, they may still be subject to administrative and service fees.
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