An individual with a 401(k) retirement plan has the option of direct rollover into an individual retirement account, transferring funds to a new employer plan or keeping the funds in the old employer's plan. Taking a taxable distribution allows access to savings but comes with income tax payments, according to New York Life Insurance Company.
Transferring funds to another employer's plan or keeping them in the current plan also avoids all taxes and penalties, states New York Life Insurance Company. However, if an individual wants access to his savings, he must deal with income tax expenses. All taxable lump-sum distributions come with a 20 percent withholding tax. If the individual is under 59 1/2, a 10 percent IRS penalty also cuts into the lump-sum distribution. The penalty is not applicable in the event of death or disability.
Rolling over the existing 401(k) into an IRA avoids all state and federal withholding taxes, along with any potential IRS penalties. An individual who received a lump-sum distribution has 60 days to invest those funds in an IRA. However, he must add the 20 percent taken out through mandatory withholding with his own money. That 20 percent is recoverable at the next income tax filing, explains New York Life Insurance Company.