The other day a buddy of mine was asking about what to do with his 401k – he had recently switched jobs and wanted to move all of his money from the old company’s plan to the new company’s plan. Simple enough.
However, when he told me how he planned to do this, I just about had a heart attack.
His initial plan was to get a hold of his old company’s 401k provider, ask them to cut him a check for whatever was in his account and then go ahead and write the new company’s 401k provider a check for the same amount once he got their information.
While this plan is perfectly legal, it’s probably one of the worse financial decisions you could ever make due to the severe tax consequences.
By having the old 401k company cut him a check, my buddy was essentially getting a distribution, which would be considered taxable income, and would get hit at whatever his current tax rate is.
On top of that, there would be an additional 10% penalty tacked on to the taxes because you are not allowed to touch money in your retirement accounts – with very few exceptions – until you’re 59 1/2 years old.
After explaining this to my buddy, I told him that the best thing for him to do would be to do the research prior to requesting the check, contact the new 401k provider and get all of the necessary rollover information from them. Once he gets this information, then he can contact the old 401k company, give them the name of the new financial institution and request that his “distribution” be made to the new company.
You see, as long as you rollover the money from one account to another without taking possession of the money (i.e. the distribution check is made out to you) you won’t incur any penalties or have to pay taxes on the money.
By following my advice, my buddy probably saved at least 35% of what his 401k is worth. And no matter how much money you have, 35% of it is a pretty big chunk of change.