Can I Keep My 401k With My Old Employer?

When transitioning jobs, a common financial question arises regarding what to do with a former employer’s 401(k) retirement savings plan. A 401(k) is an employer-sponsored retirement account that allows employees to save and invest a portion of their paycheck before taxes are taken out, with the money growing tax-deferred until retirement. Understanding the various options for these accumulated savings is important for maintaining long-term financial security.

Options for Your Former Employer 401k

Upon leaving a job, you have four primary choices for your 401(k) funds: leaving them with your former employer, rolling them into a new employer’s 401(k) plan, transferring them into an Individual Retirement Account (IRA), or cashing out the funds. Each option carries distinct financial, tax, and administrative implications that warrant careful consideration. The decision should align with your personal financial goals and risk tolerance.

Leaving your 401(k) with your old employer is often the simplest path, as it requires no immediate action. Your funds remain invested within the former plan, continuing to grow on a tax-deferred basis. However, you will no longer be able to contribute new money to this account, nor will you receive any further employer matching contributions. This option is available if your vested account balance exceeds a certain threshold.

You might find that the investment options within your former employer’s plan are limited compared to other alternatives. Additionally, as a former employee, you could face higher administrative fees that were previously subsidized by your employer. Federal law provides strong creditor protection for 401(k) assets. Required Minimum Distributions (RMDs) from the account begin at age 73, impacting future withdrawal strategies.

Rolling your 401(k) into a new employer’s plan, if available, offers an opportunity to consolidate your retirement savings. This can simplify management by keeping all your current and past employer-sponsored retirement funds in one place. Your money continues to grow tax-deferred within the new plan, and you may gain access to new investment options provided by your current employer.

Some new employer plans might offer lower fees or a broader array of investment choices than your previous plan. Funds in an employer-sponsored 401(k) retain federal creditor protection. An additional advantage is that RMDs may be delayed beyond age 73 if you are still actively working for the employer sponsoring the plan.

Another common choice is to roll over your 401(k) into an Individual Retirement Account (IRA). This option provides more control and flexibility over your investments. You can choose between a Traditional IRA, where contributions are often tax-deductible and growth is tax-deferred, or a Roth IRA, where contributions are made with after-tax money and qualified withdrawals in retirement are tax-free.

IRAs offer a wider selection of investment vehicles, including individual stocks, bonds, mutual funds, and exchange-traded funds, allowing for greater portfolio diversification. Many IRA providers also feature lower administrative fees compared to some 401(k) plans, potentially reducing the overall cost of managing your retirement savings. IRAs offer less creditor protection than 401(k)s, with the level of protection varying by state. If you convert pre-tax 401(k) funds to a Roth IRA, these converted amounts become taxable income in the year of conversion.

Cashing out your 401(k) involves taking a direct distribution of your funds, which is the least advisable option due to financial penalties and tax consequences. The entire amount withdrawn is treated as ordinary income for tax purposes. This can push you into a higher tax bracket, increasing your overall tax liability.

In addition to income taxes, if you are under age 59½, you will incur a 10% early withdrawal penalty on the distributed amount. For example, a $25,000 withdrawal could result in federal income tax plus a $2,500 penalty, not including any state taxes. The plan administrator is required to withhold 20% of the distribution for federal income tax purposes. Cashing out also means forfeiting potential future tax-deferred growth, diminishing your long-term retirement savings.

Steps to Take for Your Chosen Option

To initiate a rollover, whether to a new employer’s 401(k) or an IRA, you should first contact the administrator of your former employer’s 401(k) plan. Simultaneously, reach out to the administrator of your new employer’s plan or the custodian of your chosen IRA to inform them of your intent to roll over funds. These institutions will provide the necessary forms, such as rollover request forms or transfer forms, and may require a letter of acceptance from the receiving institution.

A direct rollover is the recommended method, as it involves the funds being transferred directly from your old plan administrator to the new plan or IRA custodian. In a direct rollover, the check is made payable to the new financial institution for your benefit, not to you personally, which helps avoid mandatory tax withholding and potential penalties. If an indirect rollover occurs, where the funds are sent to you directly, you must deposit the entire amount into a qualified retirement account within 60 days to avoid taxation and penalties. Be aware that in an indirect rollover, your former plan administrator will withhold 20% for federal income tax, and you will need to make up this 20% out of pocket to roll over the full amount.

If you opt to leave your 401(k) with your former employer, the administrative steps are minimal. In many cases, you simply do nothing, and the funds will remain in the plan. However, it is advisable to confirm with the plan administrator if any specific notification is required. You should ensure you have access to your account information, such as online portals or periodic statements, to monitor your investments and review any fee changes or plan updates.

For those who choose to cash out their 401(k), the process begins by contacting your former plan administrator. You will need to request a distribution and complete the necessary distribution request forms. The timing for receiving funds can vary, but it takes a few business days once the request is approved.