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Written by:  Rick Imhoff, CFP®

You can quickly build a sizable sum of money if you are fortunate to work for an employer who provides a retirement plan, like a 401(k), especially if your employer makes matching contributions.  Of course, at some point at the end of your employment with that company, for whatever reason, you will be faced with the decision of what to do with all that money you have accumulated.  Here are a few options to consider when making that important decision.

Take a Lump Sum

Unless you have a small balance, this option is typically not a good idea.  If you have made pre-tax contributions, and the employer made matching contributions, the entire amount would be taxable in the year withdrawn and could put you into a higher income tax bracket resulting in even further erosion of your account balance.  In addition, anyone taking a lump sum distribution under age 59 ½ would be subject to a 10% tax penalty.  

Do Nothing

The easiest option is to do nothing.  The funds can remain in the plan at your past employer and continue to be invested as you have elected.  You can continue to make changes to your investment allocation and can even request periodic or regularly scheduled distributions.

Rollover to Another Retirement Plan

If you are still employed and have a 401(k) plan with your current employer, you can make a direct rollover from your old 401(k) plan to your new 401(k) plan.  Most 401(k) plans offer this option.  The benefit of a direct rollover from one plan to another is to maintain simplicity by having your 401(k) plan investments in one place.

IRA Rollover

In many instances, the option chosen by plan participants is to rollover their entire account balance into a Traditional IRA.  To do so, you first need to establish a Traditional IRA with a bank, brokerage firm, investment manager, financial advisor, insurance company, etc. and complete the forms provided by your employer, so the plan sponsor knows where to send your money.  For income tax purposes, it is best to have your funds sent from the plan directly to your Traditional IRA, or a check mailed to you payable to the custodian or trustee of your new Traditional IRA.

The benefit of rolling over your 401(k) plan balance to a Traditional IRA is that you have significantly more investment options to choose from.  Distributions from a Traditional IRA are sometimes easier to request and faster to process than distributions from a retirement plan.   

Roth 401(k)

The four options above focus on pre-tax contributions.  However, most 401(k) plans now offer post-tax contributions to be designated as Roth 401(k) contributions, which would be segregated from the traditional pre-tax 401(k) contributions.  Plan participants can select this option to have tax-free growth and tax-free distributions.  If you made contributions to the Roth 401(k) option, you have the same four options as stated above.  The primary difference would be that distributions would be tax free when you take withdrawals at retirement, and rollovers would be made to a Roth IRA instead of a Traditional IRA.

It is important to know that if you chose to make Roth 401(k) contributions and received employer matching contributions, those matching contributions were made on a pre-tax basis and therefore would be taxable to you.  With that in mind, the four options above would apply.

As with any important financial decision, it is always best to seek professional advice to help you consider all options so you can make an informed decision for your unique situation.  

Rick Imhoff, CFP® is Executive Vice President - MidAmerica National Bank Wealth Management Group and he can be reached at rimhoff@midnatbank.com or (309) 647-5000 ext. 1130