Normally you can't take money out of your 401(k) until you hit age 59 1/2. Quitting your job is an exception: Cleaning out your account to pay for an Alaskan cruise might not be the best use of the money, but it's perfectly legal. The size of the tax bite you're going to face depends on what you do with the money in the account.
If you "roll over" some or all of your 401(k) into an IRA or your new employer's 401(k), you don't pay any taxes on the money you transfer. If you withdraw your money to make the rollover yourself, you must transfer it within 60 days or the IRS will tax it like a regular withdrawal. The plan administrator will withhold 20 percent of the account to cover the potential taxes. If you have the plan administrator transfer the money directly to another account, there's no withholding.
Take the Money
If you withdraw the money, you report it to the IRS as taxable income on your 1040. Your plan administrator withholds 20 percent, but what you ultimately pay depends on your tax bracket. If you haven't turned 59 1/2 -- the age at which withdrawals can start -- you pay an added 10 percent tax penalty on everything you take out that you don't roll over. Early withdrawal is an expensive move.
Leave the Money
When you quit, some companies make you close out your account, but many will let you leave the money in there. In that case, you can sit back while the interest accumulates tax-free until you reach your retirement age and start making withdrawals. If your 401(k) investments are doing well, this is a no-trouble, no-tax alternative. If your account is performing poorly, rolling the money over to a new 401(k) or an IRA may be more profitable.
IRAs offer a much wider range of investment options than a 401(k) does. If you have the time and the knowledge to manage your investments, rolling over to an IRA gives you greater freedom to exercise your talents. Another consideration is that if you change jobs several times and end up with multiple 401(k)s, it may become too complicated to track your investments, whereas rolling over the money keeps the total number of accounts to a minimum.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.