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When Should You Take the Money Out and Pay the Taxes?

When you leave your job, you also have the option of neither rolling the money into your own IRA nor leaving it in the company 401(k); you can also just take the money and run. However, although you might run with the money, you cannot hide it from the IRS. When you take a distribution of your 401(k) funds upon leaving the company without rolling the money into an IRA, you are responsible for paying income taxes on the money you withdraw. In addition, you are responsible for paying penalties on the money you withdraw if you are under the age of 59½.

Fortunately, buried within the Internal Revenue Code is a little-known loophole that permits former employees who had their company stock in their 401(k) accounts to transfer that stock into a regular investment account. This is considered an "in-kind distribution" that subjects the former employee to income taxes only on the value of the company stock at the time he or she bought it. This means, for example, that if the stock was worth $5,000 at the time the former employee initially purchased the company stock for the 401(k) and the stock is now worth $50,000, the former employee would pay income taxes only on $5,000 when he takes the money out of the company 401(k) plan. The remainder of the value of the stock could continue to grow. Then when the former employee sold the stock, income taxes would be limited to the lower capital gains rates.

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