Nearly everyone in our society with a stable job and a career will, at some point, be faced with the situation of needing to rollover a 401k. This is not really a very complicated task, but most people, due to an unfamiliarity with retirement accounts and investing in general, end up delaying and procrastinating, and make the whole process much more difficult than it has to be. Let’s take a quick look at the basics that you need to know.

401k Accounts

A 401k is in many ways similar to any other type of retirement account. It allows you to save money for retirement with specific tax advantages; in this case, the money that you put into your 401k and the earnings that you generate from your investments are not taxed until you begin to withdraw funds. The way that 401k accounts differ from other retirement accounts is that your 401k is tied to your employer. Even though you own the account and the money inside of it, your employer handles many of the details of the account. We’ll discuss this more later, but for now you just need to know that your 401k is linked to your employer.

If you leave your current job and have money invested in the 401k, you have to decide what you want to do with that money. Since you’re no longer an employee at that company, you cannot continue to contribute to that account. You have several options as to what you want to do with the money, and deciding between the different options is the crux of the 401k rollover issue.

401k Rollover Options

When you have money invested in a 401k at an old job, you essentially have four options as to what to do with your money: withdraw the money, leave it where it is, roll the money into a new 401k, and roll the money into an IRA. Let’s look at each of these options.

Withdrawing the money you have invested in the 401k – i.e., having your old employer cash the account out and send you a check – is the worst choice you can make financially, for several reasons. First off, the money that you have invested was put there for a reason – your retirement. Pulling the money out now defeats the purpose of putting it away for later. Secondly, you’re going to pay a large amount in taxes. Remember how the money was not taxed when you put it in? Well, if you pull it out now, you’re going to pay the regular federal and state taxes on the money, plus an additional 10% penalty. This could easily reach a 30% to 40% tax rate on your money, which means for every $1,000 you have in the 401k, you’re only going to receive $600 to $700. This is a bad move. Avoid it.

Read the second part of this article for more 401k Rollover options.