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One of the biggest blunders workers can make is to cash out their 401(k) stashes when they leave a job. But research has shown that nearly half of all workers do exactly that -- and nearly two thirds of 20-something workers choose to keep the cash when they ditch a gig!

Small sums of money can become large ones over time due to the magic of compounding, so if you cash out now, you're not only paying fees and taxes -- you're seriously endangering your future nest egg, too.

Of course, even beyond the lure of quick cash in hand, "Just cut me a check" might simply sound like the easiest alternative in what can be a difficult and stressful transition between jobs. So let's demystify the process, and go over exactly how to roll a 401(k) into an IRA, so you can be ready if the need arises.

Decisions, decisions
Right off the bat, there are a few possibilities for your 401(k) when you decide to leave a job.

  • You may be able to transfer your 401(k) to your new employer's plan.
  • If your former employer's rules allow it, you may be able to leave your 401(k) parked right where it is -- this may be simple (and certainly better than cashing out), but remember that you'll be responsible for related fees.
  • You may be able to put your 401(k) into what is more often than not the best option: a rollover IRA, which offers maximum flexibility.

A rollover IRA is a pretty nifty option, because not only can you select mutual funds for your holdings, but you can also choose stocks. Imagine buying blue chip stocks or fast-growing innovative companies instead of having to choose from among a small selection of mutual funds.

Basically, with a rollover IRA, you can do anything you'd do with a normal brokerage account -- with the exception of anything requiring margin, such as short selling -- and it's tax-deferred, too.

One step at a time... to a bright retirement
Here are the steps you should take to roll over your 401(k) into a rollover IRA.

Step 1: Contact the institution that will receive your assets.

This will likely be your brokerage, and the customer-service folks there will be eager to help you out with this, so don't be shy about asking for whatever assistance you might need. The most you should have to do is fill out some forms to establish the account.

Step 2: Contact the institution that will transfer your assets.

Since this is your old employer's plan provider -- and you're basically giving them the boot -- it might not be quite as pleasant an experience as dealing with your new institution. Again, don't be shy about asking your new institution for any help they can provide in smoothing the process. Although this is mostly on you, the folks at your new institution may be willing to give some guidance, or even place a three-way call, to make sure everything's running smoothly.

Step 3: Sit back and relax.

Once the paperwork is completed and delivered, your old plan's provider will write a check to the new brokerage, which will deposit it into your rollover IRA. The process should only take about a month, and once the money appears in your account, you'll be ready to take an active role in your retirement funds with this tax-favored investment vehicle.

Most people change jobs many times before they retire -- 10 to 12 times on average. Don't let yourself be one of the people who has a mess of balances floating around, or cashes out crucial pieces of his or her nest egg. Consolidating all those balances into a rollover IRA is a simple step that gives you manageability and an array of options -- and preserves all the tax benefits of 401(k) investments to boot. Your future self will thank you.

This article was originally written by Alyce Lomax and published on Dec. 17, 2008. It has been updated by Dan Caplinger, who doesn't own shares of any stocks mentioned in the article.

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