Retirement planning is a lifelong process that most Americans take seriously. Shortfalls during an individual's golden years can make it difficult to cover basic needs, such as housing and food costs, as well as medical expenses and similar financial obligations that may present themselves. For these reasons, many individuals explore their options when it comes to managing a 401(k) sponsored by a previous employer.

The way in which workers handle old 401(k) accounts will have heavy tax consequences. There are four ways individuals may manage this type of account.

First, individuals may choose to simply leave their account behind with their employer. Some workers choose this "set it and forget it" option because it helps them to avoid getting hit with tax penalties. However, this option can be limiting, because they may be forced to invest their 401(k) in specific funds that they have little control over. For those who want more discretion and authority over how their retirement nest egg is invested, this may not be the best option.

Another option is to roll the money over into an individual retirement account. This allows the money to continuing growing in a tax-deferred account, and workers will have more control over how their funds are invested. This can be especially beneficial for adults who think their financial circumstances may change in the future, because they can choose investments that best accommodate their financial picture.

Individuals may also have the choice of transferring their 401(k) plan to their new employer's retirement program. This can help workers avoid tax hassles and allow them to maintain their tax-free status. Keep in mind, however, that once the rollover has occurred, they must keep the funds in their new employer's account until they leave their position.

Lastly, workers may choose to cash out their 401(k) account. This can be a costly option because individuals will be required to pay taxes on their withdrawal, and those below age 591/2 will also be hit with a 10 percent early withdrawal penalty. For this reason, individuals should consider their long-term retirement goals before entertaining this option.

Making the right decision takes several factors into account, including a worker's overall retirement aims, current investment strategies and nest egg savings to date. It may be helpful to speak with a tax preparer to better understand the ramifications of each option before making a choice.

Every effort has been taken to provide the most accurate and honest analysis of the tax information provided in this blog. Please use your discretion before making any decisions based on the information provided. This blog is not intended to be a substitute for seeking professional tax advice based on your individual needs.
About Liberty Tax Service®
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