If you follow one of the 401k rollover options, you can generally avoid federal taxes and tax penalties.    If you do not handle the 401k rollover option correctly,  you may then be taxed and also incur a 10% tax penalty…so learn the rollover rules and follow them precisely.

If you use the cash out option, you will be taxed and perhaps penalized 10%.   The 10% tax penalty applies if you are under age 59 1/2 at the time you cash out the account.

Read below about the ways that you can avoid the federal taxation and 10% tax penalty.

Taxation Of The 401k Option You Choose

Avoid Taxation

401k Rollover

  • You can implement a 401k rollover to another qualified plan within 60 days of receiving your distribution.
  • With this rollover option, you actually receive the distribution check; and it is your responsibility to reinvest that check.
  • If you do not redeposit that distribution check within that 60 day rollover period, you will be taxed and incur the 10% tax penalty.
  • The IRS has very strict rules about the 60 day rollover period, so be careful.

401k Direct Transfer

  • Implement a direct transfer.  This is sometimes called a plan-to-plan transfer or a 401k transfer.
  • This is a transfer between financial institutions.
  • The distribution is made from one financial institution to another and you never receive the distribution check.
  • The 60 day rollover rule does not apply when you implement the 401k transfer like it does when you do a 401k rollover…because you never receive the distribution check.

When You Will Not Avoid Taxation

401k Cash Out

  • Your third option is to cash out your 401k.
  • When you choose the cash out option, you actually receive the distribution money and do not reinvest it in an IRA or a 401k account.
  • With the 401k cash out option you will be taxed and if you are under age 59 1/2, you will incur a 10% penalty.
  • When you use this cash out option, your credit score will not be affected.  Some investors are misled to believe that they will get a mark on their credit scores when they cash out their 401k plans.