You would be hard pressed to find any financial planner that does not recommend saving for retirement to their clients. There are, after all, numerous investment options to help an individual accumulate wealth over time. To make it even easier for people to save money, many companies now offer employee sponsored retirement plans such as the 401(k), 403(b), and 457.
While these plans are certainly a great investment option when an individual continues to be employed by the sponsoring company, what happens to their account when they change jobs or retire? When an employee elects to change jobs, or retire, it is crucial that they fully under the various IRA rollover rules.
IRA Rollover Options
When a change in employment status occurs, the employee has three basic rollover options. Perhaps the most common option is to simply cash out the account. When an employee elects to take a cash distribution, the trustee writes a check for the balance of the account. By law, the employer is required to withhold 20% of the balance as a prepayment of the estimated taxes that will be due at year end. Furthermore, unless the employee is at least age 59½, he or she will also be subject to an additional 10% withdrawal penalty.
A second IRA rollover option is known as an indirect rollover. This occurs when the employee receives a cash distribution from their account and elects to deposit the fund into a qualified Roth IRA (make sure you fully understand the various Roth IRA qualifications), Traditional IRA, 401k, 403b, or 457 plan within 60 days of the check being issued. In this scenario, the employer is still required to withhold 20% of the balance. To complicate matters even more, the employee is required to deposit the full balance of the account, including the 20% that was withheld, in order to avoid any additional taxes and penalties.
A final option is known as a direct rollover. This option is perhaps the best alternative when the employee has a long-term perspective. In a nutshell, the employee authorizes the employer to transfer the balance of their account directly to the new custodian or trustee. In this scenario, the employer is not required to withhold anything and no taxes or penalties are assessed to the employee.
If you need to rollover your retirement account due to a change in employment status, you should seek the guidance of a qualified investment professional. These highly trained individuals will be able to determine the best type of account for your specific financial circumstances.