What Happens to My 401k After I Leave a Company?

A 401(k) is an employer-sponsored retirement savings plan that allows individuals to contribute a portion of their paycheck to an investment account. These plans offer tax advantages, allowing funds to grow tax-deferred until retirement. Many employers provide matching contributions, which can boost savings.

When changing jobs, individuals must decide what to do with their existing 401(k) from a former employer. This decision involves understanding various options, each with distinct implications for taxes, access to funds, and long-term growth.

Leaving Your 401(k) with Your Former Employer

One option is to leave your 401(k) account with your former employer’s plan. The funds will continue to grow according to the plan’s investment options.

An advantage is continued tax-deferred growth. Additionally, 401(k) plans offer strong creditor protection under federal law, specifically the Employee Retirement Income Security Act (ERISA). A drawback is limited control over investment choices, as you remain subject to the former plan’s offerings. Managing multiple accounts from different past employers can also become cumbersome.

Some plans may force a distribution if your balance is below a certain threshold. For small balances, the plan administrator might automatically cash out the account, subject to taxes and potential early withdrawal penalties. For slightly larger balances, the plan might automatically roll your funds into an IRA of their choosing, often called a “force-out” IRA.

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

Transferring your 401(k) to a new employer’s plan consolidates your retirement savings into a single account. This simplifies financial management. Funds rolled into a new 401(k) continue to benefit from tax-deferred growth and retain strong federal creditor protections.

Benefits include potential access to plan features like loans or hardship withdrawals. The new plan’s investment selection may be suitable, and administrative fees could be lower. However, investment choices in a 401(k) are generally more limited compared to an Individual Retirement Account (IRA), and fees could be higher than your old plan or an IRA.

To roll over a 401(k), contact both your former and new plan administrators. A “direct rollover” is recommended, where funds transfer directly between custodians. This avoids mandatory 20% federal tax withholding. In an “indirect rollover,” if funds are paid to you, you have 60 days to deposit the full amount into the new plan. Failure to redeposit the full amount within 60 days makes the un-rolled portion a taxable distribution, potentially incurring an additional 10% early withdrawal penalty if you are under age 59½.

Rolling Over Your 401(k) to an Individual Retirement Account (IRA)

Rolling over a 401(k) into an IRA is popular due to the wider range of investment options available. This allows for a more personalized investment strategy. Consolidating multiple old 401(k) accounts into a single IRA can also simplify financial management.

While IRAs offer benefits, they may provide less creditor protection than a 401(k), as IRA protections can vary by state law. Different rules apply to early withdrawals. Rolling a pre-tax 401(k) into a Roth IRA involves paying taxes on the converted amount in the year of conversion.

For an IRA rollover, select an IRA custodian and open an account. Contact your former 401(k) administrator to initiate the rollover, specifying a direct rollover to avoid withholding and tax complications. In a direct rollover, funds are sent directly to your new IRA custodian. If you receive a check, it is an indirect rollover, and you must deposit the full amount into your IRA within 60 days to avoid it being considered a taxable distribution and potentially subject to an early withdrawal penalty.

Taking a Cash Distribution from Your 401(k)

Taking a cash distribution from your 401(k) means withdrawing funds directly instead of transferring them. This option is ill-advised due to significant financial consequences. The entire distribution from a traditional 401(k) is taxed as ordinary income in the year it is received.

In addition to income tax, if you are under age 59½, an additional 10% early withdrawal penalty applies. For example, a $25,000 withdrawal could result in thousands of dollars lost to taxes and penalties. Limited exceptions to the penalty exist, but they do not eliminate income tax liability.

Requesting a distribution involves contacting your plan administrator and completing forms. A mandatory 20% federal income tax withholding applies to most lump-sum distributions paid directly to you. This means you receive only 80% of your balance, and you are still responsible for additional income tax and the 10% penalty when filing your tax return. Cashing out results in the permanent loss of tax-deferred growth.