If you've moved on to bigger and better jobs, or been forced to leave your old job, your old employer might require you to take your 401(k) money out of the plan. Instead of sacrificing all the hard work you put in to building up the tax-sheltered account by just withdrawing the money, consider rolling over the money into another retirement account. However, you have to act fast because you only have 60 days.
TL;DR (Too Long; Didn't Read)
You have 60 day to reinvest your funds after closing your 401(k) account. Otherwise, you may have to pay income taxes and penalties.
Reinvestment Time Limit
Once you receive the money from closing your old 401(k) plan, the clock starts ticking on your 60-day time limit to reinvest the money into another account. You can do whatever you want with the money for that time period as long as the money is deposited before the 60 days are up. However, unless you have some pressing need for the money and you're sure you'll be able to have the money redeposited before the rollover window is up, there's usually no reason not to roll it over immediately.
Eligible Reinvestment Accounts
You can't just put the money you take out of the 401(k) plan, put it back into the stock market and hope Uncle Sam won't mind. Instead, you must roll it into another qualified retirement plan, such as a 403(b), IRA or another 401(k), in order to preserve the tax-deferred status of the money.
For example, your new employer's plan might accept rollovers so you could move it there. Alternatively, if your new employer doesn't have a plan for you, you can put it in an IRA. If you don't move it into another qualified plan, it's considered a permanent distribution.
Consequences of Exceeding 60 Days
If you don't reinvest the money in a qualified retirement account within 60 days, you're treated as taking the money out of the account forever. Practically speaking, this means you have to pay income taxes on the money and, unless you're over 59 1/2 or an exception applies, the 10 percent additional tax penalty. Sorry, losing your job doesn't qualify.
If later you try to put the money into an account, it's treated as two separate events: a distribution and a contribution. If the amount you try to put back in exceeds your annual contribution limit, you're stuck paying excess contribution penalties as well.
How Tax Withholding Works
The amount you receive from closing your 401(k) is likely not the amount you should be rolling over. When you take a distribution from your 401(k) plan, the plan has to withhold 20 percent of the distribution for taxes. For example, if you take out $60,000, you're only going to get a check for $48,000.
If you only roll over that $48,000, the IRS treats you as if you took a $12,000 distribution, subject to taxes and penalties. As long as you complete the rollover, you'll get the withholding back when you file your taxes.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."