If you leave an employer where you have a 401(k) plan, you might want to close out that 401(k) account. Sometimes you can let the money stay in that old 401(k), but people often want to completely cut their ties with the company and consolidate financial accounts for easier record keeping. You can reduce your liability for taxes and penalties by rolling these accounts into new tax-deferred accounts.
Your options might be limited if you want to close an account with a current employer and you're not 59 1/2 or older. Although some employers' plans allow withdrawals and account closure for any reason, many restrict participants to hardship withdrawals. Your plan might allow a withdrawal and closing of the account only if you face the loss of your home or must pay unexpected medical or funeral expenses.
With a previous employer, you can always close a 401(k) plan by requesting a withdrawal of the entire account balance. The plan administrator will sell all of the investments in your account and will issue you a check, closing the account. The plan trustee also will withhold 20 percent of the amount that you withdraw to cover any potential taxes on your withdrawal – possibly more if your state requires withholding. The money you take out will be taxed at your normal rate for income. And if you're younger than 59 1/2, you will pay a 10 percent penalty on this early withdrawal.
You can avoid taxes and penalties by depositing the entire amount that you withdrew into an individual retirement account within 60 days. Keep in mind that you'd also need to deposit an amount equal to what the administrator withheld for taxes; otherwise, that withheld amount would be considered an early withdrawal. You'd be responsible for the taxes on that amount – as well as for the 10 percent penalty if you're not yet 59 1/2 – unless you could make up those funds from other sources.
You can close a 401(k) account with a former employer by rolling the funds over to an individual retirement account. You begin this transaction by requesting the trustee of your IRA to contact the trustee of the 401(k) and ask him to sell all of the investments held in the account, and to transfer the cash from the sale to the IRA trustee. In some cases, the trustee may request the transfer of the shares of stocks or mutual funds instead of cash from the sale. Once the 401(k) trustee completes this transfer it will close the 401(k) account, as no funds would be left in the account. This transaction is tax-free, as a trustee-to-trustee transfer.
New Employer's 401(k)
If you begin work for a new employer that offers its own 401(k) plan, you can perform a trustee-to-trustee transfer of the assets from your old 401(k) to the new company's plan. The steps for this are similar to those for an IRA rollover, except that your new company's plan administrator or human resources department will help with the transfer. Generally, you can transfer funds immediately upon beginning work, and you're not subject to any waiting periods that the company requires for plan participation. You also might be eligible for plan loans under the new employer's plans, whereas a transfer to an IRA isn't eligible for loans.
Special Rules If You're at Least 55
If you terminated employment for any reason with a company and you're 55 or older, you can withdraw money from your 401(k) without the usual 10 percent penalty. By requesting a withdrawal of the entire balance, you can close your account. But keep in mind that you'll still pay taxes on the entire withdrawal, at the regular income tax rate.
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