Can I Keep My 401k If I Quit My Job?

A 401(k) plan is an employer-sponsored retirement savings account, established under Internal Revenue Code Section 401(k). It allows employees to contribute a portion of their paycheck, often with an employer match, into an investment account for retirement. Contributions to a traditional 401(k) grow tax-deferred, with taxes paid upon withdrawal in retirement. Roth 401(k) contributions are made with after-tax dollars, allowing qualified withdrawals in retirement to be tax-free. This article clarifies the options available for these funds when an individual leaves a job.

Your 401(k) After Leaving a Job

When you separate from an employer, your 401(k) account generally remains with the former employer’s plan until you take action. Understanding your vested percentage is important for your 401(k) balance after leaving a job. Vesting refers to the portion of your account balance that is truly “yours,” particularly concerning employer contributions. While your own contributions are always 100% vested, employer contributions often follow a vesting schedule.

Vesting schedules can vary, but common types include “cliff vesting” and “graded vesting.” With cliff vesting, you become 100% vested in employer contributions all at once after a specific period, such as three years. If you leave before this period, you forfeit all unvested employer contributions. Graded vesting grants you increasing ownership over time, for example, 20% vested after two years, and an additional percentage each subsequent year until you reach 100% vesting, typically within six years.

To determine your vested percentage, consult your 401(k) plan documents or contact your former employer’s human resources department or the plan administrator. These resources provide details on the specific vesting schedule that applies to your account and your current vested balance, directly impacting the amount of employer-contributed funds you can take with you.

Paths for Your Retirement Savings

After leaving a job, you have several options for managing your 401(k) funds, each with distinct characteristics regarding tax treatment and future access. The decision often depends on your financial goals and the amount of your vested balance.

Leaving Funds with Your Former Employer’s Plan

One option is to leave your funds with your former employer’s plan. This is often the default if you have a vested balance above $7,000. Your funds will continue to grow tax-deferred under the old plan’s investment rules, but you will not be able to make new contributions. Be aware of potential administrative fees and minimum balance requirements that some plans may impose.

Rolling Over to a New Employer’s 401(k)

You can roll over your funds to a new employer’s 401(k) plan. This maintains the tax-deferred status of your savings and consolidates your retirement accounts, which can simplify management. The availability of this option depends on whether your new employer offers a 401(k) plan and if their plan rules permit incoming rollovers.

Rolling Over to an Individual Retirement Account (IRA)

A common choice is to roll over your funds to an Individual Retirement Account (IRA). This transfers your tax-deferred 401(k) savings into a personal IRA, such as a Traditional IRA. IRAs typically offer a broader array of investment choices compared to employer-sponsored plans, providing greater control over your portfolio.

Taking a Cash Distribution

You can take a cash distribution of your 401(k) funds. This means directly receiving the money, but it comes with tax implications. The distributed amount is subject to ordinary income tax, and if you are under age 59½, an additional 10% early withdrawal penalty applies. This option can reduce your retirement savings and is generally considered a last resort due to these financial consequences.

Implementing Your Decision

Once you have decided on the best path for your 401(k) funds, the next step involves initiating the transfer or distribution process. For rollovers, understanding the difference between a “direct rollover” and an “indirect rollover” helps avoid unintended tax consequences.

Direct Rollover

A direct rollover, also known as a trustee-to-trustee transfer, involves the funds moving directly from your former 401(k) plan administrator to the new retirement account custodian. This method avoids tax withholding and potential penalties.

Indirect Rollover

An indirect rollover means the funds are distributed to you directly, and you then have 60 days to deposit the full amount into another eligible retirement account. If you choose an indirect rollover, your former 401(k) plan is required to withhold 20% of the distribution for federal income tax. To complete the rollover and avoid the funds being considered a taxable distribution, you must deposit the entire original amount, including the 20% that was withheld, into the new account within the 60-day period. If you do not deposit the full amount, the withheld portion, and any amount not rolled over, will be subject to income tax and potentially the 10% early withdrawal penalty if you are under age 59½.

To begin any of these processes, contact the plan administrator of your former employer’s 401(k) plan. They will provide the necessary forms and instructions for your chosen option. For a direct rollover, you will need to provide the new account’s information to the former plan administrator. Processing generally involves a few weeks for the transfer to be completed.

If you opt to leave funds with your former employer, no action is required on your part, especially if your balance exceeds the automatic rollover threshold. For a cash distribution, you will request the payout from the plan administrator, who will then process the withdrawal and apply the mandatory tax withholding.