When a participant in a 401(k) Plan terminates employment, there are typically a few options they have regarding what to do with their plan.
- Take a cash distribution – This is a taxable event (assuming all funds are pre-tax funds). The plan will automatically withhold 20% for federal taxes. It is important to note that there is also a 10% penalty for withdrawing 401(k) funds before age 59 1/2.
- Rollover the funds to an IRA or another Qualified Plan – This option is not a taxable transaction and therefore allows the participant to maintain the tax deferred benefit. A direct trustee to trustee transfer is the simplest way to do a rollover. If a participant receives a cash out distribution, and later decides to do a rollover, they have 60 days to get the funds deposited into an IRA, including the 20% Federal withholding amount.
- Keep the money in the Plan – This is usually an option if the participant balance is more than the mandatory cash-out threshold. That threshold is defined in the plan document and can be no more than $5,000.
If you want more information on this topic, please consult your tax advisor or contact Anne Christian, CPA at firstname.lastname@example.org.