What happens a lot of the time is people will either leave their money sitting in their current 401k plan with their previous employer or cash out early simply because they do not understand how to rollover their money.  While leaving your money with your previous employer is a better choice than cashing out, if you continue to do this with each job you will have multiple accounts all over the place that are not being managed as properly as they could be. This is why participating in a 401k rollover is the smartest option to choose.

Going with a brokerage account will give you a lot more flexibility with your money over a typical 401k with your employer.  With a typical 401k you have limited options to mutual funds and index funds.  If you do not have a great understanding of investing or you are fine with the options provided to you by your employers 401k plan then this may be a good situation for you.  If you want more investment options then you will benefit from a brokerage account.  With a brokerage account you have the ability to benefit from ETF’s or Exchange Traded Funds.   ETF’s are traded like stocks and you have a lot of options to chose from, thousands to choose from.  They have low expenses and there are no investment minimums which make these an extremely attractive retirement investment.  A brokerage IRA offers a great amount of flexibility not only with ETF’s but you can also purchase mutual funds, individual stocks & bonds and in most cases CD’s.

The first thing you want to do is pick a brokerage firm to rollover your 401k into. There are a lot of financial institutions where this can be completed at, however be sure to check out various discount brokers as they tend to have trades with no or lower commission.  Do some research with various companies and find the best fit for you.  You will receive a form that will authorize the direct rollover of your funds into the newly opened account.

Of course there is a disadvantage to a brokerage IRA, despite the many benefits.  The greatest disadvantage is the cost.  When you have a brokerage account you will be charged a fee every time you place a trade with most brokers, unlike most mutual funds where they have a built-in expense ratio.  Another cost is if you decide to trade an ETF you not only pay a trade commission you also have recurring operating costs built into it. So with the flexibility comes a little bit of a price but sometimes the cost is worth it.  If you want to avoid a lot of these fees research some discount or free brokerage firms.

Common Phrases:
401k ira rollover, 401k rollover ira, 401k to ira, rollover 401k to ira

If you leave a company and decide to physically receive a part of or all of your 401k assets, this is considered a cash distribution. You may think, “This is my money so I will take it and run”, and the truth is, yes, you can take the money and run but not without paying some hefty taxes first.  State and federal income taxes will take a portion out of your distribution.  When you made the contributions to your 401k you probably did so with pre-taxed dollars.  Your employer contributions were also tax deferred.  When you go with a cash distribution you pay income tax on all pre-taxed earnings. Then there is a mandatory withholding of taxes of 20%.  Yep, you read that right, 20%. So if you had $50,000 in your retirement account and you cashed out your distributions you would pay $10,000 in taxes that your previous employer must pay to the IRS.  If you are still considering this, you also may have to pay a 10% penalty called a premature distribution for withdrawing from the account if you are under the age of 59 1/2 at the time you decided to leave the company.  Essentially if you had $50,000 you would have to pay $5,000 for penalties.  So if you add all the taxes you will pay your $50,000 is now $35,000 or less all because you cashed out early [ReviewAZON asin="1413310311" display="inlinepost"]

Unfortunately, the only benefit to this option is that you have hard cash in your hands now, rather than later.  So if you are in a financial crisis, and by crisis I mean serious medical injuries or tying to save your home, not buy a new wardrobe, then this would be a good option for you to take if you are willing to take the big financial hit.  We all know the tax man is going to get any money he can from us but this is also to deter you from withdrawing early.  The point of a retirement savings account is so that it can continue to grow and earn you money so you can one day retire.  If you withdraw early you have now taken a big chunk of that money and thrown it away.  Please think about your options and look into the 401k rollover options available whether it’s a 401k rollover to IRA or 401k rollover into your new employer’s retirement plan.  A cash distribution option is not something to take lightly. The money in hand seems nice but you will miss it greatly when you are retired! You may need to seek the advice of a tax adviser if you are still unsure about taking a cash out or if you need a third party to help you decide whether this is your best financial option.

Summary:

• Cash Distributions are only a good idea if you are in a financial crisis and need the money.  Speak with a tax advisor or 401k professional to determine if this is your best option.
• You will get dinged quite a bit by the tax man for cashing out early
• If you are unsure of what to do with your money, leave it in your current 401k plan until you have done some research or consulted with a professional regarding your next move