Early distribution of one’s 401(k) account (provided that certain exceptions are not met – leaving one’s job is not one of the exceptions) can be subject to not only income tax but also a 10% penalty on the full distribution. If you are younger than 59½ years old, leave your job for any reason and your employer informs you that you must withdraw and clear your 401(k) account within a specified time frame, then the following do’s and don’ts will help guide you through the process and avoid incurring penalties and additional income tax liability.

DO:
     <>  Open a Traditional IRA account with the financial institution of your choice and instruct the institution with your 401(k) account to directly rollover the entire 401(k) account balance to the Traditional IRA account.
     <>  Heed the correspondence from your former employer and accomplish the account transfer within the specified timeframe.
     <>  Deposit into a Traditional IRA account, the entire amount of any 401(k) account funds distributed directly to you. Taxpayers have 60 days (not necessarily 2 calendar months) from the distribution date to complete and have the transfer considered as a qualified rollover. Remember that any difference between the total 401(k) distribution and the received distribution (sometimes income taxes are withheld) may incur a 10% penalty and additional income tax liability.

DON’T
     <>  Do not have your 401(k) account balance distributed directly to you. Unless certain exceptions are met or you comply with qualified rollover limitations as stated above, the distribution may be subject not only to income tax but also an added 10% penalty.
     <>  Do not rollover 401(k) funds into a ROTH IRA account. 401(k) accounts are deferred tax accounts, ROTH IRA’s are not, so the two are not interchangeable. 401(k) accounts can not be directly converted to ROTH IRA accounts. There is a method for accomplishing a conversion indirectly but certain limitations and criteria must be met.

This article contains basic information for dealing with one’s 401(k) account after terminating job employment. Tax law on this subject is complex and each company 401(k) plan will vary, thus each individual’s position needs to be assessed based on their specific situation. Please call or email us with particular circumstances so that we may provide a tax friendly solution.