As you walk out the door for the last time with your old company, you may be running through a mental checklist of all the things you need to remember to take with you such as your old files, your pictures on your desk and your degrees hanging on your wall. Your 401(k) plan should also be on that list. Knowing your options helps you figure out the best choice for your retirement assets.
Leave it Alone
Your employer may permit you to leave the money in the 401(k) plan after you leave the company. If so, consider the plan's investment options and fees before rushing to move your money. Sometimes bigger companies can negotiate lower fees on behalf of their employees so that you pay less than you would to have the money in an individual retirement account. In addition, if your old 401(k) plan holds employer stock, it is best to leave that portion of the 401(k) with the old company because of the special tax treatment on distributions.
Roll it Over
You can also elect to roll over the money in your 401(k) plan into another qualified retirement plan. If you move on to another job that offered a qualified plan, such as another 401(k) or 403(b), you may be able to roll over the money into that plan, if the plan rules permit it. You can also roll it into a traditional IRA so that you have more control over the money and you can combine it with your personal retirement savings. By rolling it into another tax-deferred plan, you generate no tax liability and you get to maintain the tax-sheltered status of the money.
You can also consider rolling the money into a Roth IRA or, if your new employer offers it, a Roth 401(k) or Roth 403(b). Roth plans offer the opposite savings effects of traditional plans: nondeductible contributions but tax-free withdrawals -- which makes a Roth a strong consideration if you anticipate facing higher tax rate at retirement. For example, if you lose your job at the start of the year and have not found another one, if you can afford the taxes on the conversion, you may benefit in the long run because you likely will fall in a lower income tax bracket for the year than you will pay at retirement.
Once you leave your employer, IRS rules permit you to cash out all or a portion of your 401(k) plan balance. Unless you are at least 59 1/2 years old, however, you have to pay a 10 percent early distribution penalty on top of your income taxes. Even if you meet the age requirement, taking out the money is not necessarily the best idea because once you remove it, you have to pay income taxes on any future gains whereas if you leave the money in the account or roll it into another qualified plan, you can avoid those taxes.