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Retirement Accounts: Transfer vs. Rollover


When you get laid off, what should you do about your 401(k)? See more banking pictures here.
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There were rumors of layoffs at your company for months. Earnings were down, management brought in a team of consultants in dark suits, and the mood was bleak. Then you got the e-mail: the CEO called an "all hands" meeting for 4 p.m. today.

With a pit in your stomach, you and your colleagues march down to learn your fate. By 4:15, you and half of your department are in the human resources office getting a cheery speech about life after layoffs. The HR rep hands you a thick packet of information, smiles weakly, shakes your hand, and you're out the door. After ten years with the same company, you are officially unemployed. Now what?

Losing a job is a trying time, not least for financial reasons. You rely on that monthly paycheck to pay the mortgage, cover the bills, pay off debt and save for retirement. Which reminds you, what happens to the 401(k) account that you've been building up for the past decade? Can you keep the money where it is, or do you have to move it somewhere else? And if you decide to cash in the account, will you be taxed on that money as if it's income? Time to crack open that HR information packet.

If this situation sounds familiar, you're not alone. Whether you are laid off from a job or choose to leave, you need to decide how to manage the funds saved in your retirement account. If you choose to cash in the account, you will have to pay both income tax on the money, plus a 10 percent early withdrawal penalty for taking a distribution before the age of 59½ [source: Brandon].

To avoid a tax hit, most people opt to move the money from their 401(k), 403(b), pension program, or other qualified employee retirement account to an Individual Retirement Account (IRA). IRAs are offered by banks and investment houses and allow you to continue using that 401(k) money to buy stocks and bonds and save for retirement. Your employer is required to allow you to roll over the money into an IRA, but you have several options for making the move, each with its own rules, restrictions and tax implications.

Let's start by defining some important terms: transfer and rollover. The main difference between transfers and rollovers is that you can only transfer money between two retirement accounts of the same type -- an old 401(k) to a new 401(k), for example, or one traditional IRA to another traditional IRA [source: Charles Schwab]. If you want to move money between two different types of retirement accounts, however -- including 401(k) to IRA -- that's called a rollover.

We'll talk more about rollovers on the next page.


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