If I Quit My Job, Do I Get My 401(k)?

A 401(k) plan is a tax-advantaged retirement savings vehicle where contributions and employer matching funds grow tax-deferred. When individuals change jobs or leave employment, a common question arises: what happens to these accumulated funds? This article clarifies the process of managing your 401(k) funds after separating from an employer.

Determining Your Vested 401(k) Balance

Vesting refers to the ownership of contributions made to your retirement account. While your own contributions are always 100% vested immediately, employer contributions, such as matching funds, often come with a vesting schedule. This schedule dictates when you gain full ownership of the employer’s contributions.

Employer contributions typically follow one of two common vesting schedules: cliff vesting or graded vesting. Under a cliff vesting schedule, you become 100% vested in employer contributions after a specific period, such as two or three years of service. If employment ends before this period, you may forfeit all unvested employer contributions. In contrast, graded vesting allows you to gradually gain ownership of employer contributions over several years, perhaps 20% or 25% per year, until you are fully vested after a period like five or six years.

To ascertain your vested 401(k) balance, contact your former employer’s human resources department or the plan administrator directly. They can provide a detailed breakdown of your vested and unvested amounts. Your most recent 401(k) statement, often accessible through an online portal, usually contains information about your vested balance.

Options for Your 401(k) Funds After Leaving Employment

After determining your vested 401(k) balance, several options are available for managing these funds.

One option is to leave the money in your former employer’s 401(k) plan. This is often permissible if your vested account balance exceeds a certain threshold, commonly $5,000. If the balance is below this amount, the plan administrator may automatically cash out your account or roll it over into an IRA. Leaving funds in the old plan allows them to continue growing tax-deferred, subject to the plan’s investment options and administrative fees.

Alternatively, you can roll over your 401(k) funds into a new employer’s qualified retirement plan, such as a new 401(k) or 403(b), if your new employer’s plan accepts such transfers. This option allows your retirement savings to consolidate into a single account within your current employment. The funds continue to grow tax-deferred under the rules and investment choices of the new plan.

Another common choice is to roll over the funds into an Individual Retirement Account (IRA). This provides a broader range of investment options and allows you to manage your retirement savings independently. The funds maintain their tax-deferred status.

The final option is to cash out your 401(k) by taking a direct distribution. While this provides immediate access to funds, it generally comes with tax consequences and potential penalties, which can substantially reduce the amount you ultimately receive.

Executing a 401(k) Rollover or Withdrawal

Understanding the procedural steps for a rollover or direct withdrawal is essential. Rollovers are executed in two primary ways: a direct rollover or an indirect rollover.

Direct Rollover

A direct rollover, also known as a trustee-to-trustee transfer, involves the funds moving directly from your former employer’s 401(k) plan to your new retirement account, such as an IRA or a new 401(k). This method is generally preferred because it avoids immediate tax withholding and potential penalties.

To initiate a direct rollover, contact your former 401(k) plan administrator and provide them with the account details of your new retirement vehicle. The administrator will then process the transfer directly, ensuring the funds maintain their tax-deferred status without passing through your hands. This process usually involves completing specific forms provided by the former plan administrator and the new financial institution.

Indirect Rollover

An indirect rollover, also known as a 60-day rollover, involves the plan administrator sending the funds directly to you. When this occurs, the plan is required by the Internal Revenue Service (IRS) to withhold 20% of the distribution for federal income taxes. You then have 60 days from the date you receive the funds to deposit the full amount, including the 20% that was withheld, into a new qualified retirement account. If you fail to deposit the full amount within this 60-day window, the un-rolled portion becomes a taxable distribution, subject to ordinary income taxes and potentially an early withdrawal penalty.

Cashing Out Your 401(k)

Choosing to cash out your 401(k) by taking a direct distribution involves different procedures and financial implications. To request a direct distribution, complete a distribution request form provided by your former 401(k) plan administrator. Any amount distributed directly to you is immediately subject to taxation.

The entire distributed amount is taxed as ordinary income. This means the funds are added to your other income for the year and taxed at your marginal income tax rate. Furthermore, if you are under age 59½, the distribution is generally subject to an additional 10% early withdrawal penalty.

Beyond the income tax and potential 10% penalty, 401(k) distributions paid directly to you are subject to a compulsory 20% federal tax withholding. This means that if you request a $10,000 distribution, you would only receive $8,000 initially, with the remaining $2,000 sent to the IRS. This 20% withholding is applied regardless of your age or whether you intend to roll over the funds. If you do not complete a 60-day rollover for the full amount, you will still owe taxes on the entire distribution, and the 20% withheld may not cover your full tax liability, potentially leading to additional taxes owed at tax time.