Decisions Regarding Your 401K Have a Major Impact on Personal Debt

Many people have begun to realize just how important a retirement savings plan is for their financial futures. Consistently investing money throughout the course of one's life is the best way to ensure that adequate funds will be available when retirement rolls around. People are not excited about the idea of delaying their retirement goals and they are not interested in the prospect of living off of credit and running up debts. So it is not surprising that participation in savings plans has become very common in recent years. One of the most popular long term investment vehicles that individuals use today is the 401K.

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A 401K is an investment plan that is offered through an individual's employer. These investments are subject to some excellent tax advantages. First of all, the invested amounts are not counted as taxable income. Secondly, the earnings on the money grow on a tax deferred basis. Another great benefit that is often associated with 401ks is matched employer contributions. Many employers will match an individual's investment up to a certain percentage of their pay. This gives the employee the opportunity to receive "free money". These advantages have resulted in nationwide participation in 401K plans. However, there is one big question that these plans raise. What happens to the money if I change jobs?

• Take the cash. Cashing out your investment is generally not the best choice to make. You are subject to a 10% penalty if you are under 59 ½. In addition your employer can remove 20% of the distribution total as pre-payment of federal income tax. People who cash out their plans are often tempted to spend the money which defeats its intended purpose. Keep in mind the reason you began the plan originally was to prepare for the future and prevent extensive debts.
• Leave the money where it is. You are subject to the existing plan guidelines and are able to continue taking advantage of the tax advantages. However, the employer will no longer match funds. Also, if your total amount is under $5,000 your employer has the right to make you leave the plan.
• Roll over into new employer's plan. You are not subject to any rollover penalties and will enjoy the same tax advantages.
• Roll over to an IRA. You are not subject to any penalties and you have the same great tax benefits. However, you also have much greater flexibility in where to invest your money.
• Indirect rollover. This involves cashing out all or a segment of the investment and then rolling over all or some of the money into an IRA or into the new employer's 401K plan. The money that is not kept will be subject to taxation and may qualify for the 10% early withdrawal penalty. If you decide to roll over 100% of the money then the 20% that was withheld needs to be reimbursed through personal funds. (1)

If you find yourself contemplating a job change you need to take a hard look at the alternatives surrounding your 401K. Everybody has different circumstances in their lives but we all have one thing in common; the need to prepare for our financial futures. Wise decisions now can lead to comfortable debt free living in the future.

(1) http://www.401k-hotline.com/distribution/index.php#

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About the author:

Mark Carney is a professional consultant with First American Debt Consolidation and Loans, a debt consolidation service specializing in financial education, credit counseling, and debt management services nationwide.