Don't forget 401)k) fund when switching employers

Changing jobs can be stressful. You have to get used to new responsibilities and new surroundings.

One of the last things on your mind is what to do with your 401(k) from your previous employer, but improper handling of your 401(k) distribution can be a costly mistake.

You generally have two options for handling your 401(k) funds once you switch jobs:

A. You may continue to defer paying taxes on the money by rolling over all or part of it directly into a traditional individual retirement account or qualified plan.

Keep in mind that not all employers allow partial or direct rollovers from an ex-employer's plan into their plan.

B. You may take possession of all or part of your account balance.

You will pay federal taxes and state taxes, if applicable, and perhaps a 10 percent penalty tax, on the amount you don't roll over.

The plan could have restrictions on the frequency and timing of distributions that can be made.

A rollover occurs when you distribute the funds from your 401(k) retirement plan, tax-sheltered annuity or IRA and deposit the proceeds into another qualified plan or IRA. The amount rolled over is not included in your gross taxable income for the current year and does not increase your tax liability for that year.

With a direct rollover transfer, your employer sends the amount of your 401(k) account balance directly to your choice of financial institutions or another plan custodian, such as your new employer's retirement plan, bank or brokerage.

Your employer is not required to withhold any federal income taxes with this option.

If you choose an indirect rollover, your employer pays your 401(k) account money directly to you. You then have 60 days to deposit all or part of these assets into your traditional IRA to continue the benefits of tax deferral.

If your employer pays your retirement account balance directly to you, your employer is required by law to withhold 20 percent of your distribution for federal income taxes.

The intent of the law is to encourage you to not keep your account assets, but rather to roll the funds over into a retirement account to keep them working for your retirement.

The 20 percent withholding works like this: Let's assume your 401(k) plan balance is $100,000.

If you choose to receive that money, rather than having it directly rolled over, your employer must withhold $20,000 (20 percent of $100,000) and distribute the remaining $80,000 to you.

You would still have 60 days to roll over the funds to continue deferring taxes, but to complete a full rollover, you would have to deposit the original amount of $100,000. Since only $80,000 was paid to you, you would have to come up with $20,000.

If you don't deposit the entire $100,000, the $20,000 that was withheld will be taxed.

If you can afford to replace the $20,000 with other funds, you won't owe any additional tax on the distribution.

Keep in mind that, until the amounts withheld are refunded, you've temporarily lost the use of the replacement funds.

And remember, when you switch jobs, if you do not want to be limited by the investments offered in your new employer's plan, you can always roll over your previous retirement funds into a traditional IRA.

Your financial consultant can help you determine the best plan.

(The preceding article was provided by Timothy M. Reese, vice president of investments and assistant branch manager with A.G. Edwards and Sons Inc.)