There are many misconceptions about what must be done with a 401(k) when someone leaves a company.  Some people think they have to cash out their 401(k) upon leaving a job.  Others think they must “roll it over” into a new 401(k).  Still others believe that they must leave the 401(k) where it is.  None of these are true, and none are false.  These aren’t “musts,” they are options.  The big question is: which option is the right option for YOU?

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If you have enough money in your current 401(k) to meet the minimum requirement, you could leave your money where it is.  Should you?  Well, it depends.  If you feel the plan has good investment choices and the annual fees are reasonable, leaving your money there to mature could be a good option for you.

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If your new employer offers a 401(k), you could choose to “roll” your money into that plan, but then you will be limited to the new plan’s investment options.  So should you?  Once again, it depends.  You’ll want to look into the structure of the new plan, the fees and the investment options.

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Optionally, you may wish to move your money into an IRA rollover account, which will generally offer more flexibility.  It also offers you more distribution options, once you are eligible.  

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The temptation to get a lump sum of money can be too great for some, especially if they have just lost their job or feel that they are in some sort of financial bind.  They may choose to cash out their 401(k) upon leaving a job.  But what are they giving up?  Well, 10% for starters.  If they are younger than 59 ½ years old and cash out their 401(k), most of them will incur a 10% penalty.  Additionally, they will owe taxes on the amount they cash out.  But here’s what really hurts: they are giving up part of their retirement fund or (in many cases) starting over from zero.

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Fighting temptation now could lead to big rewards later…

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For example, let’s say a 35-year old leaves a job and rolls over $45,000 from a 401(k) into an IRA earning an average of 7% annually*, letting the money mature over 30 years…by the time of retirement, that money could potentially grow to over $340,000.

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Source 1: http://www.irs.gov/taxtopics/tc424.html

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*The rate of return provided here is an example, not indicative of a current rate of return available, and is used for the sole purpose of illustrating the power of compounding.  This example does not take into account distributions or other possible fluctuations in an account.

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