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401(k) Rollover Penalty Free

Starting employment at a new company can be a exciting experience but many organizations offer 401(k) retirement plans which have to be dealt with when pursuing new job opportunities. It may not be exciting to deal with a 401(k) from a former employer but there may be important tax liabilities and penalties if not handled correctly.

There are a few different options available when dealing with an employer's 401(k) and these options should be fully evaluated before deciding which course to take. The two most common options are either a direct rollover between companies or existing Individual Retirement Account or to have a payment made from the 401(k) directly to you. Depending on which option is chosen, forms will need to be filled out to ensure a smooth transition.

Starting a new job and rolling over a 401(k) may be the perfect opportunity to open an IRA at any one of many financial institutions. Often company sponsored 401(k)'s can feel limited in investment opportunities and therefore this may be the best time to open an Individual Retirement Account at a personal bank or brokerage firm. If you always wanted to invest your retirement in individual stocks or have more control then a bank or brokerage IRA may be a great option.

Direct Rollover

The more traditional option, and for that matter the simplest, is to do a direct rollover between retirement accounts. Whether going from a 401(k) to an IRA or from a 401(k) at a former employer two a new employer, direct rollovers normally only require signing a few documents for the process to happen seamlessly.

If conducting a direct rollover of 401(k) proceeds then your former employer will normally provide complete paperwork outlining the proceeds from the account and what is required to roll it over into an IRA or another company plan. During this process the former employer should make clear whether the funds will be a direct transfer into the other retirement account or whether a check will be made payable to the new IRA account but mailed to you which would require mailing or depositing the check into the new account.

Cash Out

A tempting possibility, especially when reviewing the retirement account information with your former employer, is to have the account liquidated and a check made directly to you. This however can have serious financial and tax repercussions which should be fully understood before a decision is made. If a 401(k) distribution check is made then there will be a mandatory 20% withholding for tax purposes. Certain criteria must be met in order to avoid this penalty.

Due to the proceeds having been received from a retirement account, there has already been a tax benefit and in order to avoid penalty these funds would need to be deposited into a new IRA or 401(k) plan within 60 days of receipt. It is also required to deposit 100% of the 401(k) account proceeds so the check you received would have to be accompanied with additional funds to match the account balance as specified by the former employer and deposited into a new retirement account.


It is always best and simplest to conduct a transfer or rollover from one retirement account to another. If however money is withdrawn and not deposited into a qualified retirement account then any money received would be taxed at your current tax rate and counted as earned income. In addition, because those funds had a tax benefit there will be an additional 10% penalty on the withdrawn funds before age 59 1/2.

These complications can be mitigated however if the funds received from the former 401(k) account are used in a way that meets IRA exemption guidelines such as the purchase of a first time home are qualifying medical expenses. While this may seem like the perfect opportunity to go back to school or buy a home it is still counterproductive because retirement funds have a longer time horizon and greater overall benefit if they continue to work for the account holder.


The best case scenario when starting a new job is to sign a few papers, fill out a few forms and have your existing 401(k) rolled over or transferred into a new company 401(k) plan or Individual Retirement Account. The seamless transition ensures a long-term time horizon focused on financial security.