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

When you change jobs, your 401(k) is a significant financial consideration. This employer-sponsored retirement savings plan holds funds you and often your employer have contributed. Understanding your options after leaving a company is important to protect your savings and ensure their continued growth.

Understanding Your 401(k) After Leaving

Your contributions to a 401(k) plan are always 100% yours, irrespective of how long you worked for the employer or the circumstances of your departure. This includes any pre-tax or Roth contributions you made from your paycheck, along with any investment gains on those amounts.

Employer contributions, however, may be subject to a “vesting schedule,” which dictates when these funds become fully owned by you. Common vesting schedules include “cliff vesting,” where you become 100% vested after a specific period, often three years, or “graded vesting,” where you gain ownership gradually over several years, such as 20% per year over six years. If you leave before fully vesting, you might forfeit a portion of the employer’s contributions. Employer contributions made to certain plans, like Safe Harbor 401(k)s or SIMPLE 401(k)s, are 100% vested immediately.

After your employment ends, your 401(k) account remains intact with the former plan administrator. You will receive information or forms from the plan administrator outlining your choices for the account. These choices involve leaving the funds where they are, moving them to another retirement account, or taking them as a taxable distribution.

Evaluating Your Distribution Options

When you leave an employer, you have several primary options for your 401(k) account. Each choice carries distinct advantages and implications, particularly concerning taxes and access to your funds.

Leaving the money in your former employer’s 401(k) plan is often an option, especially if your account balance exceeds a certain threshold. This allows your funds to continue growing tax-deferred and generally offers strong creditor protection. However, you cannot make new contributions, investment options might be limited, and you may face administrative fees. Tracking multiple old accounts can also be challenging.

Rolling over funds to another retirement account allows your savings to continue growing tax-deferred. You can roll over funds to your new employer’s 401(k) plan if it accepts rollovers. This consolidates your retirement savings, making them easier to manage. However, investment choices and fees in the new plan might differ.

Alternatively, you can roll over your 401(k) into an Individual Retirement Account (IRA). This option provides a broader range of investment choices, offering greater flexibility and control. You can choose between a Traditional IRA, where funds grow tax-deferred, or a Roth IRA, which allows for tax-free withdrawals in retirement after a Roth conversion (a taxable event).

The method of rollover has significant implications. A “direct rollover” is the most straightforward and recommended approach. Funds are transferred directly from your old 401(k) plan administrator to your new 401(k) or IRA custodian. You do not personally receive the funds, so no taxes are withheld, and the entire amount is transferred. This avoids pitfalls related to handling the money yourself.

An “indirect rollover” involves you receiving a check for your 401(k) balance. The plan administrator withholds 20% for federal income tax. You have 60 days from receipt to deposit the full amount, including the withheld portion, into your new retirement account. To avoid taxation and penalties, you must use other personal funds to cover the withheld 20%. Failing to deposit the entire amount within 60 days makes the distribution fully taxable as ordinary income, plus a 10% early withdrawal penalty if you are under age 59½.

Cashing out your 401(k) by taking a lump-sum distribution is not recommended. The entire distribution is taxed as ordinary income. If you are under age 59½, you will also incur an additional 10% early withdrawal penalty. This immediate tax burden and penalty can significantly reduce your savings and eliminate the benefit of tax-deferred growth, impacting your retirement funding.

Initiating a Rollover or Withdrawal

Once you decide on the best path for your 401(k) funds, contact your former employer’s human resources department or the 401(k) plan administrator. Request the necessary forms and information for distributing your account balance. The plan administrator manages the procedures for accessing your retirement funds.

For a direct rollover, instruct your former plan administrator to transfer funds directly to your new 401(k) plan or IRA custodian. Provide the new account number and receiving institution’s details. This ensures funds move seamlessly.

If you opt for an indirect rollover, the plan administrator issues a check payable to you. Remember the 60-day deadline for depositing these funds into your new retirement account. The check will have 20% federal income tax withheld, requiring you to contribute additional personal funds to deposit the full original amount within 60 days. Missing this deadline results in a taxable withdrawal, potentially incurring income taxes and early withdrawal penalties.

To cash out your 401(k) for a lump-sum payment, request this option through the plan administrator. Funds will be sent directly to you. The plan administrator withholds 20% for federal income tax. You are responsible for any additional taxes owed, including state income tax and the 10% early withdrawal penalty if applicable.

Throughout these processes, you may need to provide specific documentation, including new account numbers and the receiving financial institution’s contact information. Providing accurate details helps facilitate a smooth transaction.

Special Situations

Certain situations can affect what happens to your 401(k) when you leave a company, requiring specific considerations.

If your 401(k) account balance is small, below $7,000, your former employer’s plan may have specific rules. Plans might automatically cash out accounts below $1,000, sending a check. For balances between $1,000 and $7,000, the plan may initiate an automatic rollover into a default IRA if you do not provide instructions. Contact your former plan administrator to understand their thresholds and procedures.

An outstanding 401(k) loan requires consideration when leaving your job. Many plans require full repayment upon separation. If the loan is not repaid by the specified deadline (which can vary, sometimes extending to the following year’s tax filing deadline), the unpaid amount is treated as a taxable distribution. This balance is subject to ordinary income tax, plus a 10% early withdrawal penalty if you are under age 59½.

For individuals holding employer stock within their 401(k), Net Unrealized Appreciation (NUA) rules offer a tax planning opportunity. NUA is the increase in value of employer stock from its original cost basis. If you take a lump-sum distribution of your entire 401(k) account and the employer stock is distributed “in-kind,” you pay ordinary income tax only on the original cost basis. The NUA portion is taxed at lower long-term capital gains rates only when you sell the shares. Further appreciation after distribution is taxed as short-term or long-term capital gains based on your holding period.

Be aware of specific deadlines for decisions or transfers. The 60-day rule for indirect rollovers is a strict deadline; missing it can result in significant tax consequences. Act promptly to avoid penalties and taxes. Plan administrators may also have their own timeframes for processing requests, so contact them early.