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Hello and welcome to Money Girl’s Quick and Dirty Tips for a Richer Life.

Today’s topic: Sit, stand, roll over.

Several listeners, including Maureen in New York and Michelle M., e-mailed me asking what they should do with their savings in an employer-sponsored retirement plan after leaving a job.

When you change jobs or retire, you have options about what to do with your employer-sponsored retirement plan, such as a 401(k). You can cash it out. You can leave it right where it is. You can transfer it to your new employer’s plan. Or, you can transfer it into what’s called a rollover IRA.

So how do you decide which choice is right for you?

Here are some important tips to consider.

Cashing out your 401(k) is usually not a good idea because it will cost you. You must pay state and federal income taxes on the money and, if you are under age 59 1/2, you must also pay a 10% penalty for early withdrawal. So if, for example, you have $10,000 in your 401(k) and you decide to cash it out after leaving your job, the 10% penalty would reduce your $10,000 to $9,000. The $10,000 would also be reduced by taxes. If your combined state and federal tax rate were, say, 35%, you’d pay taxes of $3,500 on that $10,000 distribution. So after the penalty and taxes, you’d keep only $5,500 of your original $10,000. Ouch! For these reasons, cashing out is rarely a good choice. It makes sense only if you’re facing a hardship and need immediate access to the money.

If you’re happy with the range of investment options available to you in your previous employer’s 401(k), you could choose to leave the funds right where they are. Most employer-sponsored plans, however, limit you to just a handful of mutual funds. In most cases, you’ll have a much broader selection of investment choices available to you if you move the funds to an IRA custodian of your own choosing. I’ll give some tips on how to choose an IRA custodian in an upcoming episode.

When you change jobs, your new employer may allow you to directly transfer your old 401(k) to their 401(k) plan. But again, most employer-sponsored plans typically have limited investment choices, so consider this option only if you’re really happy with your new employer’s plan.

In most cases, when you leave your job, your best choice is to do a direct rollover of funds from your 401(k) into a rollover IRA. This option puts you in control and gives you more investment options than you’d typically get by either leaving the money in your old 401(k) or by moving it to your new employer’s 401(k).

When doing a rollover, be sure to let your employer’s plan and your new IRA custodian know that you’re doing a “direct rollover,” also known as a “trustee-to-trustee” transfer. With a direct rollover, the funds are transferred directly from your 401(k) plan to your IRA custodian and you will not pay a penalty or taxes. The check for the funds is made out to your IRA custodian, not you.

It’s important to specify that you’re doing a direct rollover so your employer’s plan doesn’t mistakenly assume you’re withdrawing the funds. If your employer’s plan makes the check out to your name, they must withhold 20% for taxes. This would leave you in a pickle if your intention were to roll over the money to an IRA. You’d need to come up with the missing 20% and you wouldn’t get that 20% back until after you filed your tax return.

So remember, specify that you’re doing a direct rollover or trustee-to-trustee transfer when rolling over your 401(k) to an IRA.

When rolling over a 401(k) to an IRA, you can roll it over to either a rollover IRA or a traditional IRA. Here’s the difference: With a rollover IRA, you can later transfer the money into a future employer’s retirement plan if you should ever want to. With a traditional IRA, you don’t have this option.

After your funds have been rolled over, they will typically be sitting in your IRA as cash. When the transfer is complete, you’ll need to take action to re-invest the funds.   

So here’s wishing you smooth rollovers that are free of penalties and taxes.

Cha-ching! That’s all for now, courtesy of Money Girl, your guide to a richer life.

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As always, everyone’s situation is different, so be sure to consult a tax or financial advisor before making important financial decisions. This podcast is for educational purposes only and is not intended to be a substitute for seeking personalized, professional advice.

If you’d like to request a topic or share a money tip of your own, e-mail it to money@qdnow.com or call it in to my voicemail line: 877-6-RICHER.

Money Girl is part of the Quick and Dirty Tips network. This week Mr. Manners is talking about how to politely inform someone that their zipper is down, so be sure to check out his show.

Thanks for listening!