Common Mistake: Cashing Out Your 401(k)

• You pay taxes on the distribution.
• You pay a premature distribution penalty on the withdrawal.
• You lose the opportunity for that small 401(k) to grow over the years.

Here are the options you have when leaving a company:

• Leave the money in your former employer’s plan.
• Roll over the money into an IRA or your new employer’s plan.
• Take a lump sum distribution and pay taxes on the whole amount at once.

Taking a lump sum distribution is a huge mistake, because you’ll pay more taxes and lose the ability to grow wealth. If you roll over your 401(k) into an IRA at a brokerage firm, you can choose from hundreds of investment options, not just those offered in your new employer’s plan.

Whichever you choose, your safest bet is to have the 401(k) transferred directly to your new plan. You might also have the option of keeping your old 401(k) where it is, which could make sense if you are the type of person who will keep track of that account, the investment choices are better, and the administrative costs are lower than your new employer's plan. If the proceeds of your 401(k) are sent directly to you, it is imperative that the money be rolled over within 60 days to a traditional IRA or you’ll pay a penalty and taxes. Since the money in the 401(k) hasn’t been taxed yet, it must be rolled over into a traditional IRA, not a Roth IRA.

Tip: Diversify

Make sure the money you’re investing for retirement is spread among different kinds of investments. Don’t make the mistake of putting too much money in one stock, especially if it’s your employer. If your employer runs into problems, both your job and your retirement account will be in jeopardy.

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