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Part 9: Retirement Money

The retirement account from the old job is the easiest system to harm in a hurry and the easiest to leave alone safely. Slow down here on purpose. Nothing in this chapter has a 60-day clock running today unless you start a distribution. Starting one starts clocks. Understand them before you do.

The four options for an old 401(k)

1. Leave it where it is. If your plan's terms allow it, the money can stay in the former employer's plan, invested as it is. Whether this is open to you, and what happens with smaller balances, is set by your plan's rules: plans can have their own handling for accounts below their stated thresholds, including moving a small balance to an IRA for you or paying it out. Read every notice the plan sends in the first 90 days. Doing nothing is a legitimate choice when the plan allows it and the fees and fund choices are acceptable to you. It is a choice, though, not an oversight. Write down that you chose it.
2. Roll it to an IRA. You open an IRA and have the plan send the money there. How the money moves matters more than where it lands. See the rollover section below.
3. Roll it to a new employer's plan. If a new job offers a plan and that plan accepts rollovers, the money can move plan to plan. The new plan's documents control whether it accepts incoming rollovers and what forms it requires.
4. Cash it out. The plan sends you the money and the account is done. The IRS position is plain: distributions from a 401(k) are taxable unless they are rolled over, and if you are under age 59 and a half, a taxable portion that is not rolled over may also be subject to a 10 percent additional tax on early distributions. Cashing out is the only option on this list that shrinks the account by taxes and possibly that additional tax on the way out, and the money stops being retirement money the day it lands. This guide takes no position on your emergency. It insists you see the full price tag first, in your own numbers, in Worksheet 5.

Direct and indirect rollovers are different animals

A direct rollover means the plan transfers the distribution straight to another eligible plan or to an IRA. Under this option, per the IRS, no taxes are withheld. This is the clean path, and it is the one to ask for by name.

An indirect rollover means the distribution is paid to you, and you deposit it into an eligible plan or IRA yourself. Two federal rules govern it:

• You have 60 days from the date you receive the distribution to complete the rollover. Miss it and the amount not rolled over is taxable income for that year, with the early distribution tax possibly on top.
• If the distribution came from an employer plan, the plan must withhold 20 percent for federal tax before paying you, even if you tell the plan you intend to roll the whole amount over. To defer tax on the entire distribution, you must deposit the full amount, which means making up the withheld 20 percent from other funds and recovering the withholding later through your tax return. Deposit only what you received and the withheld slice counts as a taxable distribution.

Keep the accounts separate in your mind: that 20 percent mandatory withholding is an employer-plan rule. An indirect rollover from an IRA works differently; IRA withholding is not the mandatory 20 percent and can be elected and adjusted. Do not let a form or a phone agent blur the two. The IRS page for this, Rollovers of Retirement Plan and IRA Distributions at irs.gov, lays both out, and it is listed in the sources at the back.

The loan trap

If you have an outstanding loan from your 401(k), separation changes its footing. Your plan's loan terms control what happens next: many plans offset the loan, which means the unpaid balance is treated as a distribution to you, once employment ends and the loan is not repaid under the plan's schedule.

Here is the deadline that matters, and it has two versions:

• If the offset happens because your employment ended or the plan terminated, you have until your federal tax filing deadline, including extensions, for the year of the offset to roll that amount into an IRA or another eligible plan and keep it out of taxable income. This longer window is federal law, per the IRS guidance on plan loan offsets.
• An offset for any other reason keeps the standard 60-day rollover window.

Either way, the rollover takes cash from somewhere: you deposit the offset amount from other funds, because the loan money is already spent. Find out whether you have a loan, what the balance is, and what your plan does at separation, in week one, from the plan statement and one logged phone call. A loan offset discovered at tax time is a deadline already half spent. Write the correct deadline, filing deadline or 60 days, in Worksheet 2 with its kind: federal rule.

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