What To Know About Your 401(K) When Switching Jobs

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Switching employers and not sure how to handle that 401k? Start here.

• Money & Finances: How-To • Money & Finances: Retirement • Money & Finances: Saving • Money & Finances: Taxes & IRS

You've built up a nice little 401(k) without paying any taxes at your current job. You’re about to take a brand new job with an increase in salary and you’re really excited. When you get ready to switch your 401(k) balance from your current account to the new 401(k) account, your former employer will cut you a check for the balance in your current account. Who your former employer makes that check out to will determine whether you have to pay taxes or absorb those early withdrawal penalties.

If your former employer makes that check out to you, they will withhold 20 percent for taxes. You'll recover this 20 percent when you file your next tax return, but that’s not the only problem there. You'll be required to deposit 100 percent of that money into an account within 60 days. If you don't, you'll be taxed. If you're too young to withdraw the money from your 401(k) then you'll also be penalized.

To keep this from happening to you, you'll need to set up a direct rollover. This is also called a trustee-to-trustee transfer. To do this you'll want to go to the bank that oversees the new 401(k) you wish to set up. Talk to them to get the information about who your former employer should make the check out to. After you have the information, contact the person who is the administrator of the retirement plan at your former job. Give them the information so you can be sure the check is made out correctly.

You're more experienced with 401(k)s now, and you know you should contribute as much as your employer will match. Sometimes your employer doesn't match your funds. Other times you don't like your choices given for investment. In that case, you can choose to set up an IRA—Independent Retirement Account. The traditional IRAs function much like 401(k)s. You still get a tax deduction for your contributions and you don't have to start paying taxes until you begin withdrawing the income.

Another IRA you might want to consider is a Roth IRA. They are a little different. In this type, you do have to pay taxes on your contributions. When you decide to retire after age 59 and begin withdrawing the money, you don't pay income tax on those funds. If you're currently in a lower tax bracket than you will be after age 50, this can be to your advantage.

In an IRA, the limits are usually lower in this type of fund, but they can still be a good alternative or even a supplement if you choose, to a 401(k) plan. With the IRA, you usually have a larger range of options for investment. If you need to do so, you can borrow money from this account one time every 12 months and won't have to pay penalties or interests if you repay within 60 days.