Question

When changing jobs, the preferred way of handling your 401K account balance with your old employer is to:

a) Convert your account balance with your old employer to cash and use it to pay off your mortgage balance.

b) Have the 401k service provider at your new place of employment arrange to have your old account balance placed in an account at your new employer’s 401K plan in what is known as a provider to provider rollover.

c) Have your old employer write a check to you for your account balance with your old employer so that you can deposit that check with your new employer.

Answer 1

A 401K is a qualified retirement plan that allows eligible employees of a company to save and invest for their own retirement on a tax deferred basis. Only an employer is allowed to sponsor a 401K for their employees. You decide how much money you want deducted from your paycheck and deposited to the plan based on limits imposed by plan provisions and IRS rules. Your employer may also choose to make contributions to the plan, but this is optional.

It is your responsibility to decide if you want to participate in the 401K, and if so, how much you will contribute each pay period. If you earn $750 each pay period and elect to defer 5% of your pay, $37.50 is taken out of your pay and placed in the 401K plan. These contributions are deducted from your salary on a pre-tax basis. This means that by contributing to a 401K, you actually lower the amount you pay in current income taxes. For example, instead of being taxed on the full $750 per pay period, you are only taxed on $712.50 ($750 minus your 401K contribution of $37.50 equals $712.50). You don't owe income taxes on the money contributed until you withdraw it from the plan.

You have two best options when it comes to rolling over your money:

1. A direct rollover, which means your money is transferred straight from one account to another. (Option B). The best option

If you decide to roll over an old account, contact the 401(k) administrator at your new company for a new account address, such as “ABC 401(k) Plan FBO (for the benefit of) Your Name,” provide this to your old employer, and the money will be transferred directly from your old plan to the new or sent by check to you (made out to the new account address), which you will give to your new company’s 401(k) administrator. This is called a direct rollover. It’s simple and transfers the entire balance without taxes or penalty.

2. An indirect rollover, which means you receive a check from your old account and have to send it to your new account. (Option C). Good not great.

This is a somewhat riskier method  is the indirect or 60-day rollover in which you request from your old employer that a check be sent to you made out to your name. This manual method has the drawback of a mandatory tax withholding—the company assumes you are cashing out the account and is required to withhold 20% of the funds for federal taxes. This means that a $100,000 401(k) nest egg becomes a check for just $80,000 even if your clear intent is to move the money into another plan.

3. The last thing to be done using your 401K is paying off a mortgage loan. (Option A)

401K accounts have money which is supposed to get a person through his/her retirement smoothly. It should not be considered as spare money to be used on a whim. However, it can be be considered if a dire need arises.

Another reason it should not be considered is because of the limit on how much you can borrow, paying the mortgage in full is unlikely. For example, if you have a $150,000 mortgage balance and you have $200,000 fully vested in your 401(k), you can only borrow $50,000, and so you'll still have $100,000 left to pay on your mortgage.

Keep in mind that if you pay off a mortgage with a 401(k) after retirement, you can do so without taking out a loan and without paying the 10 percent tax penalty, as long as you're 59 1/2 or older.