Can You Keep Your 401k If You Leave Your Job?

When you leave a job, your accumulated 401(k) funds remain yours. You face several important decisions about the future of these funds, each with distinct implications for your financial well-being. This article explores the choices available and provides guidance on navigating these options.

Your Choices When Leaving a Job

Upon leaving an employer, you typically have four primary options for managing your 401(k) account:

Leave your funds within your former employer’s 401(k) plan. Your money stays invested, maintaining its tax-deferred status, though you will no longer be able to make new contributions to the account.
Roll over your 401(k) to your new employer’s 401(k) plan, if they offer one and their plan allows for incoming rollovers. This involves transferring the funds directly from your old plan administrator to your new plan, consolidating your retirement savings in one place.
Roll over your 401(k) into an Individual Retirement Account (IRA). This involves moving your funds into a personal retirement account, which can be either a Traditional IRA or a Roth IRA, depending on your tax planning goals.
Cash out your 401(k), which means taking a direct distribution of the funds. While this provides immediate access to the money, it typically comes with significant financial consequences.

Understanding the Implications of Each Option

Leaving your funds with your former employer’s 401(k) plan can be a straightforward option, as it requires no immediate action. However, this choice may come with limitations such as restricted investment options, potential for higher administrative fees as a former employee, and limited control over your savings. Your access to statements or customer service may also diminish over time. For some plans, especially those with small balances, the former employer might automatically roll over the funds to an IRA or even cash out the account if it falls below certain thresholds, such as $7,000. Required Minimum Distributions (RMDs) will eventually apply to these accounts, generally starting at age 73.

Rolling over your 401(k) to a new employer’s plan offers the benefit of consolidating your retirement savings, making them easier to manage. This option maintains the tax-deferred status of your funds. However, you must confirm that your new employer’s plan accepts rollovers. The new plan’s investment choices, fees, and administrative features should be evaluated to ensure they align with your financial objectives. While still employed, RMDs from this plan may be delayed past age 73.

Rolling over your 401(k) into an Individual Retirement Account (IRA) generally provides the broadest range of investment options and potentially lower fees compared to employer-sponsored plans. If you roll over a pre-tax traditional 401(k) to a Traditional IRA, the funds continue to grow tax-deferred, and there are no immediate tax consequences for the rollover itself. If you choose to roll over a traditional 401(k) to a Roth IRA, this is considered a Roth conversion, meaning the pre-tax amounts converted become taxable income in the year of conversion. While this results in immediate taxation, qualified withdrawals from a Roth IRA in retirement are tax-free, and Roth IRAs are not subject to RMDs for the original owner.

Cashing out your 401(k) is almost universally discouraged due to severe financial penalties. Any distribution you receive is generally subject to your ordinary income tax rate. If you are under age 59½, an additional 10% early withdrawal penalty typically applies to the distribution amount. For example, if you withdraw $10,000 from your 401(k) before age 59½, you could lose a substantial portion to taxes and penalties, potentially over 30% depending on your tax bracket. Cashing out significantly depletes your retirement savings, sacrificing years of potential tax-deferred growth and compounding.

Executing a Rollover

There are two primary methods for executing a rollover: a direct rollover and an indirect rollover.

Direct Rollover

A direct rollover, also known as a trustee-to-trustee transfer, is the most common and recommended method because it avoids immediate tax implications and withholding. In this process, your former 401(k) plan administrator transfers the funds directly to the new account custodian, whether it’s an IRA or a new employer’s 401(k). You initiate this by contacting both your former plan administrator and the new financial institution or plan administrator. They will typically require specific information, such as account numbers, the precise amount to be transferred, and the recipient institution’s details. The funds are usually sent via electronic transfer or a check made payable directly to the new plan or custodian, not to you personally. This ensures the money never passes through your hands, thus preventing mandatory tax withholding.

Indirect Rollover

An indirect rollover, also known as a 60-day rollover, involves your former plan administrator distributing the funds to you directly. If you choose this method, the plan is legally required to withhold 20% of the distribution for federal income taxes. For example, if you request a $10,000 distribution, you would only receive $8,000, with $2,000 withheld for taxes.

You then have 60 days from the date you receive the funds to deposit the entire original distribution amount into a new qualified retirement account. To avoid taxes and penalties on the full amount, you must replace the 20% that was withheld from your own other funds. If you fail to redeposit the full amount within the 60-day window, the un-rolled portion becomes taxable income for that year and may be subject to the 10% early withdrawal penalty if you are under age 59½. Due to the complexities, mandatory withholding, and strict deadline, indirect rollovers carry more risk than direct rollovers.

Regardless of the rollover method chosen, both the old plan administrator and the new custodian will require specific documentation and forms to process the transfer. The timeline for a rollover can vary, generally taking anywhere from a few days to several weeks, depending on the institutions involved and the complexity of the transfer. Following up with both the sending and receiving institutions after submitting your request can help ensure the process is completed smoothly and efficiently.