Best Thing to Do With a 401k When Leaving a Job

A 401(k) is an employer-sponsored retirement savings plan that allows employees to contribute a portion of their income, often with employer matching contributions. These plans offer tax advantages, such as pre-tax contributions that reduce current taxable income in a traditional 401(k), or tax-free withdrawals in retirement for a Roth 401(k). When an individual leaves a job, decisions about these accumulated retirement funds become necessary.

Keeping Your 401(k) with Your Former Employer

One option for managing a 401(k) after leaving a job is to leave the funds in the former employer’s plan. This is typically permissible if the account balance exceeds a certain threshold, which is typically $7,000. If the balance is below this amount, the former employer might automatically cash out the account or roll it into an Individual Retirement Account (IRA).

Before deciding, gather information from the former plan administrator regarding whether the plan allows former employees to retain accounts, available investment options, and associated fees. Clarify access methods for account information. While funds can continue to grow tax-deferred, individuals generally cannot make new contributions to the account.

If you choose this option, notify the plan administrator and confirm contact information. Regularly review investment elections to ensure they align with your financial goals, as plan options and rules may change.

Transferring to a New Employer’s Plan

Another option involves rolling over the 401(k) funds into a new employer’s retirement plan, such as a 401(k), 403(b), or 457 plan. This can be a convenient way to consolidate retirement savings, making it easier to manage a single account.

Assess the new plan’s eligibility requirements, investment options, and fees. Inquire about its rules for accepting rollovers and the necessary documentation from your former plan administrator. Understanding these features helps determine if the new plan is a suitable destination for the funds.

The most common method is a direct rollover, where funds are sent directly from your former plan to the new one. This avoids tax withholdings and penalties. Contact both plan administrators to initiate this process and complete any required forms.

Moving Funds to an Individual Retirement Account

Rolling over a 401(k) to an Individual Retirement Account (IRA) is a widely utilized option, offering flexibility and control over investments. IRAs typically provide a broader range of investment choices compared to employer-sponsored plans, including various mutual funds, exchange-traded funds (ETFs), and individual stocks. This can allow for greater customization of an investment portfolio to align with personal financial objectives.

When considering an IRA rollover, understand the two primary types: Traditional IRAs and Roth IRAs. Rolling over pre-tax 401(k) funds into a Traditional IRA maintains their tax-deferred status. Converting pre-tax 401(k) funds to a Roth IRA requires paying income taxes on the converted amount, but qualified withdrawals in retirement are tax-free. Choosing a financial institution for the IRA involves evaluating factors such as investment options, fee structures, and customer service quality.

The direct rollover is the preferred method for moving funds from a 401(k) to an IRA. This involves the former 401(k) administrator sending the funds directly to the chosen IRA provider, often via a check made payable to the new IRA custodian. This method ensures the tax-deferred status of the funds is maintained without triggering immediate tax consequences or penalties. The process generally involves contacting the former 401(k) plan administrator and providing them with the new IRA account details for the transfer.

An alternative, less common method is the indirect rollover, also known as a 60-day rollover. With this approach, the funds are distributed directly to the individual, who then has 60 days to deposit the full amount into a new IRA or another eligible retirement plan. A significant drawback is the mandatory 20% federal income tax withholding. If the individual wishes to roll over the entire original amount, they must deposit not only the amount received but also an additional sum equal to the 20% that was withheld, from other personal funds, within the 60-day window. If the full amount is not rolled over within 60 days, the unrolled portion is considered a taxable distribution and may be subject to a 10% early withdrawal penalty if the individual is under age 59½.

Withdrawing Your 401(k) Funds

While it is an option, directly withdrawing funds from a 401(k) upon leaving a job typically carries significant financial consequences. This action is generally not advisable unless under specific circumstances where no other options are feasible. Before considering a withdrawal, understand your current income tax bracket and your age relative to the penalty threshold of 59½.

To request a direct cash distribution, contact the former 401(k) plan administrator and follow their specific procedures. The entire amount withdrawn from a traditional 401(k) is typically treated as ordinary income for tax purposes in the year of the withdrawal. This means the distribution is added to other income and taxed at the individual’s marginal income tax rate, potentially pushing them into a higher tax bracket.

In addition to income taxes, withdrawals made before age 59½ are generally subject to a 10% early withdrawal penalty imposed by the Internal Revenue Service (IRS). Limited exceptions to this penalty exist, such as for certain medical expenses, disability, or separation from service at age 55 or older. Other exceptions may apply for specific emergency personal expenses or for victims of domestic abuse.

Furthermore, plan administrators are typically required to withhold 20% of the distribution for federal income taxes. This mandatory withholding is a prepayment of taxes, not the total tax liability, and may not cover the full amount owed. Any amount withheld must be accounted for when filing income taxes for the year of the withdrawal.