If I Quit, What Happens to My 401k?

When you leave employment, a key question arises regarding the future of your 401(k) retirement savings plan. Understanding these choices is important for managing your long-term financial health. This article outlines the paths available for your 401(k) after employment ends.

Keeping Your Retirement Savings with Your Former Employer

One option for your 401(k) funds after leaving a job is to leave them within your former employer’s plan. This choice is available if your account balance exceeds a certain threshold, often $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.

No new contributions can be made to the account when funds remain in the former employer’s plan. Your investments will continue to grow or decline based on the chosen funds’ performance. Some plans may charge ongoing administrative fees to former employees, which can erode your savings over time.

Access to your funds will still be governed by the plan’s rules, including age restrictions for penalty-free withdrawals. This option suits those comfortable with existing investment options and fees, or who prefer not to manage the funds themselves immediately.

Moving Your Retirement Savings to Another Account

Moving your retirement savings to another account offers more control and flexibility. This involves a rollover, which transfers funds from your former employer’s 401(k) to another qualified retirement account without triggering immediate taxes or penalties. Two primary destinations for a rollover are a new employer’s 401(k) or an Individual Retirement Account (IRA).

Rolling over funds to a new employer’s 401(k) allows you to consolidate your retirement savings into a single plan, simplifying management. This option may also provide access to loan features, which are generally not available from IRAs. However, investment choices within a new 401(k) plan are limited to what the new employer offers, and these plans can also have administrative fees.

Alternatively, rolling over your 401(k) to an IRA, either Traditional or Roth, provides a broader range of investment options and greater control over your portfolio. A rollover to a Traditional IRA maintains the pre-tax status of your funds, meaning distributions in retirement will be taxed as ordinary income. If you choose to roll over to a Roth IRA, this is a Roth conversion, and the pre-tax amount converted will be subject to income tax in the year of conversion, but qualified distributions in retirement will be tax-free.

Rollovers can be executed as either a direct or an indirect rollover. In a direct rollover, funds transfer directly from your former employer’s 401(k) plan administrator to the new retirement account custodian. This method ensures that no taxes are withheld and the transaction remains tax-free and penalty-free. For an indirect rollover, a check for your 401(k) balance is issued to you. You then have 60 days from receipt to deposit them into a new qualified retirement account. Indirect rollovers from a 401(k) are subject to a mandatory 20% federal income tax withholding, which you must make up from other sources to roll over the full amount within 60 days.

Withdrawing Your Retirement Savings

Withdrawing your 401(k) funds as a cash distribution is an option, but it carries substantial financial consequences. When you take a cash distribution, the entire amount is considered ordinary income and added to your taxable income for the year, unless you had after-tax contributions. This can push you into a higher tax bracket.

Distributions not directly rolled over are subject to a mandatory 20% federal income tax withholding. If you request a check for your 401(k) balance, you will receive only 80% of the total, with 20% sent to the IRS as a prepayment of taxes. You will still owe income tax on the full amount.

Distributions taken before age 59½ are subject to an additional 10% early withdrawal penalty. This penalty is assessed on the taxable portion of the distribution, significantly reducing the amount you actually receive. For example, a $10,000 withdrawal could result in $2,000 withheld for federal taxes and an additional $1,000 penalty, leaving you with only $7,000 before state income taxes are considered.

There are exceptions to the 10% early withdrawal penalty:
Separation from service at age 55 or older
Distributions due to total and permanent disability
Distributions for unreimbursed medical expenses exceeding a certain percentage of your adjusted gross income
Substantially equal periodic payments
Qualified higher education expenses
Qualified first-time home purchases, generally up to a lifetime limit of $10,000

Withdrawing funds directly from your 401(k) should generally be considered a last resort due to the immediate tax burden and the loss of future tax-deferred growth on your retirement savings.

Navigating the Process After Quitting

After deciding on your 401(k) action, initiate the process with your former employer’s plan administrator or recordkeeper. This is the financial institution holding your 401(k) account. You can find their contact information on your last 401(k) statement or by contacting your former employer’s human resources department.

When contacting the administrator, specify your chosen option: leaving funds, rolling them over, or taking a cash distribution. They will provide necessary forms, such as a distribution request or rollover instruction form. Carefully review these documents and accurately fill in all required information.

For rollovers, provide the account details of your new retirement plan, including the receiving institution’s name and account number. If opting for a direct rollover, indicate this on the form to ensure funds transfer without passing through your hands. You may also need to provide supporting documentation, such as a copy of your driver’s license for identity verification.

Submit completed forms according to the administrator’s instructions, which may involve mailing, faxing, or uploading them through a secure online portal. Processing times can vary, typically ranging from a few days to several weeks. Follow up to confirm the transaction has been completed and your funds moved or distributed as requested.