According to the most recent data from the Bureau of Labor Statistics, the average time an American worker was with an employer is 4.6 years.

When you switch jobs, one key task is transferring your regular 401(k), Roth 401(k) or other tax-advantaged retirement plan. Neglecting this task could leave you with a trail of retirement accounts at different employers, or even nasty tax penalties should your past employer simply send you a check that you did not reinvest properly in time.

“Workers are much more transient today,” says Scott Rain, tax senior at Schneider Downs & Co., in Pittsburgh, Penn. “If you leave your 401(k) at each job, it gets really tough trying to keep track of all of that. It’s much easier to consolidate into one 401(k) or into an IRA.”

Moving Your Money

Technically, when you shift funds that were in a 401(k) or IRA by receiving a check that you then deposit into the new account, it is called a rollover. If the money is transferred electronically from one account to another, it's called a direct transfer. Colloquially, people call both types a rollover, but that's not the most precise legal terminology.

Why is this important? Because the IRS is so concerned that it get its hunk of your taxes if you miss the 60-day deadline for penalty-free fund shifting that it makes your previous employer withhold 20% of your funds if you receive a check made out to you, instead of using a direct electronic transfer or a check made out to an IRA custodian to roll over your account. If you complete the rollover on schedule, you are supposed to get the money back at tax time, but it is another reason to go electronic if at all possible.

Rolling Over a 401(k)

When you leave an employer before retirement, you have four options for your 401(k). You can:

  • Keep your 401(k) with your former employer
  • Roll the assets into an IRA or Roth IRA
  • Consolidate your 401(k) into your new employer’s plan
  • Cash out

Whatever you decide, if you take the money in cash instead of transferring it directly to the new account, you only have 60 days to deposit the funds in a new plan. If you miss the deadline – even if you took a check made out to the new plan but failed to get it deposited in time – you will be subject to withholding taxes and penalties. Let's look at each of these options.

– Keeping Your 401(k) with your Former Employer

If your former employer allows you to keep your funds in its retirement account after you leave, this may be a good option, but only in certain situations, says Colin F. Smith, president of The Retirement Company in Wilmington, N.C.

Staying in the old plan may make sense “if you like where you are and they may have investment options you can’t get in a new plan,” says Smith. “The other main advantage is that creditors cannot get to it.”

Additional advantages to keeping your 401(k) with your former employer include:

  • Maintaining the money management services.
  • Special tax advantages: If you leave your job in or after the year you reach age 55 and think you'll start withdrawing funds before turning 59½, the withdrawals will be penalty free.

Some things to consider when leaving a 401(k) at a previous employer:

  • If you plan on changing jobs a few more times before retirement, keeping track of all of the accounts may become cumbersome.
  • You will no longer be able to contribute to the old plan – and in some cases, may no longer be able to take a loan from the plan.
  • Your investment options are more limited than in an IRA.
  • You may not be able to make a partial withdrawal and may have to take the entire amount.
  • If your assets are less than $5,000 you may have to proactively remain in the plan. If you don’t notify your plan administrator or former employer of your intent, they may automatically distribute the funds to you or to a rollover IRA.

Procedure. Contact your former employer's plan administrator or HR department to learn what you need to do.

– Rolling the Assets into an IRA or Roth IRA

Moving your funds to an IRA is the route financial experts advise in most instances. “Now you’re in charge and you have more investment flexibility,” said Smith. Try not to go it alone, he advises. “Once you roll the money over, it’s you making the decisions, but getting a financial professional should be the first step.”

Your first decision: whether to open a traditional IRA or a Roth.

Traditional IRA. The main benefit of a traditional IRA is that your investment is tax-deductible now; you put pre-tax money into an IRA and those contributions are not part of your taxable income. If you have a traditional 401(k), those contributions were also made pre-tax and the transfer is simple. The main disadvantage is that you have to pay taxes on the money and its earnings later, when you withdraw them. You are also required to take an annual minimum distribution starting at age 70½, whether if you’re still working or not.

Roth IRA. Contributions to a Roth IRA are made with post-tax income; money you have already paid taxes on. For that reason, when you withdraw it later neither what you contributed nor what it earned is taxable – you will pay no taxes on your withdrawals. Investing in a Roth means you think the tax rates will go up later, said Rain. “If you think taxes will increase before you retire, you can pay now and let the money sit. When you need it, it is tax free,” said Rain.

You are also not required to take annual distributions at age 70½. And if you’re under age 59½, you can withdraw money penalty-free for certain reasons, such as a qualifying first-time home purchase or qualified education expenses.

If your money is currently in a Roth 401(k), the transfer will be straightforward (see Know The Rules For Roth 401(k) Rollovers). If you want to shift money from a traditional 401(k) to Roth IRA status, get the advice of a financial advisor.

Procedure. A direct transfer is the simplest way to make the shift, although a check made out to the bank or investment firm holding your new IRA will also protect you from having your previous employer take the 20% tax from the distribution.

– Rolling Over to Your New Employer’s 401(k)

If your new employer has a plan that allows immediate rollovers, and you like the ease of having a plan administrator manage your money, consider this step instead of opening an IRA. Also, if you plan to continue to work after age 70½, you may be able to delay taking distributions on funds that are in your current employer's 401(k) plan.

The benefits are the same as they are in keeping your 401(k) with your previous employer, except that you will be able to make further investments in the plan as long as you remain in your new job.

Procedure. Speak to your new employer’s HR department or plan administrator to see whether the company offers this option and how you can arrange the shift.

– Cashing Out: The Last Resort

Avoid this option except in true emergencies. First, you will be taxed on the money. In addition, if you’re no longer going to be working, you need to be 55 to avoid paying an additional 10% penalty. If you’re still working, you must wait to access the money without penalty until age 59½.

Most advisors say that if you must use the money, withdraw only what you need until you can find another income stream. Move the rest to an IRA or similar tax-advantaged retirement plan.

For more information on all these situations, including what to do with your 401(k) funds at retirement, read Should You Roll Over Your 401(k)?

Rolling Over an IRA

Sometimes, you may decide that you want to switch the financial institution that holds your IRA(s). Perhaps you've found a custodian with better investment options or you want to consolidate your IRAs, invest them differently or convert some or all of them from traditional to Roth IRAs.

If you haven't been watching tax laws carefully, you may recall that you are permitted to roll over your IRAs once a year. That is no longer exactly true – and not knowing about this change could cost you a lot of money.

Since a tax ruling in March 2014, taxpayers are only allowed a single IRA rollover in any 12-month period, regardless of how many IRA accounts they have. A transition period allows people to still roll over IRA funds from more than one account in 2014, as long as they complete all but one of the shifts by December 31. See Avoid Taxes On IRA Rollovers for details on how the tax clock works for IRA rollovers – and check with your financial advisor or accountant to be sure you're in compliance.

Procedure. The actual process is basically the same as rolling over or transferring a 401(k). The safest and simplest approach is to do a direct trustee-to-trustee transfer, in which the funds are moved electronically. You can also receive a check and deposit it with the new IRA custodian, as long as you do it within 60 days to avoid penalties. See Common IRA Rollover Mistakes.

Special rules apply if you want to shift your funds from a traditional IRA to a Roth, including income limitations. See How To Convert A Non-Deductible IRA Into A Roth IRA and How Can I Fund A Roth IRA If My Income Is Too High To Make Direct Contributions?

To learn more about the safest ways to do IRA rollovers and transfers, download IRS publications 575 and 590 from the IRS website. And be sure to check carefully for fees before choosing your plan.

See Analysis: Should You Get A Gold IRA? and Gold IRA Rollover if you're interested in this option.

The Bottom Line

The key point to remember about all these rollovers is that each type has its rules. It's important to be sure that you are in compliance so you can benefit from the tax advantages and not find yourself paying penalties.

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