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

Leaving a job often presents a decision point for your 401(k) retirement savings. These employer-sponsored plans hold your contributions and any vested employer matches, continuing to grow tax-deferred even after your employment ends. Making an informed choice about these funds is important for your long-term financial strategy. Understanding the available options will help you navigate this transition effectively.

Understanding Your 401(k) Options

When you leave an employer, you have several options for your 401(k) assets. One common choice is to leave the funds in your former employer’s plan, if allowed. If your balance is substantial, over $7,000, most plans permit this arrangement, though you can no longer contribute to it. Your investments continue growing tax-deferred within the existing plan structure.

Another option is rolling over the funds into an Individual Retirement Account (IRA). This can be a Traditional or Roth IRA, depending on your tax preferences and 401(k) type. IRAs provide a broader selection of investment choices than many 401(k) plans, and offer more control over your money.

You can also roll over funds into your new employer’s 401(k) plan. This simplifies your retirement savings by consolidating funds in one place. However, not all new employer plans accept rollovers, so confirm eligibility.

A final option is cashing out the funds, taking a lump-sum distribution. This provides immediate access to your money, but comes with significant tax consequences and penalties. Experts advise against cashing out unless necessary due to these drawbacks.

Gathering Information and Making Your Decision

Before deciding on your 401(k), gather information from your former employer and plan administrator. Ascertain your vested balance, the portion of your account that fully belongs to you. This includes your contributions and any employer contributions that have met the vesting schedule. Employer contributions vest over several years, while your own contributions are always 100% vested.

Request a copy of the Summary Plan Description (SPD), which outlines the plan’s rules, distribution eligibility, available forms, and any limitations on leaving funds. Confirm the contact information for the plan administrator and inquire about the forms required for a distribution or rollover. These forms will ask for details such as your account number, your chosen distribution type, and the receiving institution’s information. For example, if rolling over to an IRA, you will need the IRA custodian’s name, address, and your new IRA account number. If rolling over to a new employer’s 401(k), you will need similar details for that plan.

When deciding, evaluate factors such as fees associated with each option. Compare the administrative and investment fees of your old 401(k), a potential new employer’s 401(k), and various IRA providers. Consider the range and quality of investment options available in each scenario, as IRAs often offer broader choices than 401(k) plans. Assess the ease of access to funds and any rules regarding loans or hardship withdrawals, which are generally available only from current employer plans. Finally, understand the creditor protection offered by each account type, as 401(k)s typically offer stronger protection than IRAs.

Executing Your Distribution or Rollover

Once you have gathered information and decided on your option, execute the transaction. For a direct rollover, which is generally the most straightforward method, instruct your former 401(k) plan administrator to transfer the funds directly to your new IRA custodian or new employer’s 401(k) plan. This typically involves the administrator sending a check made payable to the new custodian or an electronic transfer. This method avoids you physically receiving funds, reducing the risk of tax issues.

If you opt for an indirect rollover, the former plan administrator will issue a check made out to you. The plan is required to withhold 20% of the distribution for federal income tax. The full tax implications are detailed in the next section.

For a cash distribution, request the funds be paid directly to you. This payment is also subject to mandatory 20% federal income tax withholding.

After completing forms, submit them to your former plan administrator. This can be done through mail or an online portal. Expect confirmation of the request, and the process takes a few days to a few weeks for funds to be disbursed or transferred.

Tax Consequences of Your Choices

The tax implications of your 401(k) decision are important. If you cash out your 401(k) funds, the entire distribution is taxed as ordinary income in the year received. If you are under age 59½, you incur a 10% early withdrawal penalty. Exceptions include separation from service at age 55 or older, or disability.

A direct rollover from your old 401(k) to an IRA or new employer’s 401(k) is a non-taxable event. Your retirement savings continue to grow tax-deferred without triggering immediate income tax or penalties. This method maintains the tax-advantaged status of your funds, allowing for continued growth.

For an indirect rollover, the plan administrator must withhold 20% of the distribution for federal income tax. To avoid the distribution being fully taxable and subject to penalties, you must deposit the entire amount, including the 20% withheld, into another qualified retirement account within 60 days. If you do not deposit the full amount, the unrolled portion is treated as a taxable distribution, and if you are under age 59½, it is also subject to the 10% early withdrawal penalty. Regardless of the distribution method, you will receive Form 1099-R from your former plan administrator, detailing the distribution for tax reporting.