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

When leaving a job, understanding your 401(k) options is important for managing your retirement savings. This guide clarifies the pathways for your funds.

Reviewing Your Current 401(k)

Before deciding on your 401(k) after job separation, gather specific details about your existing account. Locate your plan administrator, such as Fidelity, Vanguard, or Empower, as this entity manages your 401(k) account. You can typically find this information on your most recent account statements or by contacting your former employer’s human resources department.

Understand your vested balance. Your vested balance represents the portion of your 401(k) that you fully own and can take with you upon leaving your employer. All contributions you made from your salary are always 100% vested. Employer contributions, such as matching funds, often become vested over time according to a specific schedule, which could be immediate, graded, or cliff vesting.

Account statements reveal investment options and fees. Fees impact retirement savings growth. Some plans may have higher administrative or investment management fees, which could influence your decision to keep funds in the old plan.

Familiarize yourself with the plan’s distribution rules and timelines. Some plans may have mandatory distribution rules for small account balances, requiring that funds below a certain threshold (e.g., $1,000 or $7,000) be automatically cashed out or rolled over to an IRA.

Finally, identify any outstanding loans against your 401(k) and their repayment terms upon separation, as these can have immediate tax implications if not addressed. Addressing these loans promptly is crucial to avoid unexpected tax burdens.

Exploring Your 401(k) Options

After gathering information, evaluate the primary options for your retirement savings. Each choice has distinct characteristics and consequences, especially regarding tax treatment and access to funds.

You can leave funds in your former employer’s 401(k) plan, often permissible if your vested balance exceeds $7,000 (as of 2024). No new contributions are allowed, but investments grow tax-deferred. Be aware of potential administrative fees and limited withdrawal options.

Another common choice is to roll over your funds to a new employer’s 401(k) plan, if available. This involves a direct transfer of funds from your old plan to your new plan, maintaining the tax-deferred status of your savings. A direct rollover means the funds are sent directly from the former plan administrator to the new plan, preventing you from ever taking possession of the money. This method avoids immediate taxation and the mandatory 20% federal income tax withholding that applies if the funds are paid directly to you.

Alternatively, you can roll over your 401(k) funds into an Individual Retirement Account (IRA). This process typically involves a direct rollover, where funds are transferred from your 401(k) plan to an IRA custodian. Rolling over to an IRA, whether a Traditional or Roth IRA, can offer broader investment choices and potentially lower fees compared to some employer-sponsored plans. Funds rolled into a Traditional IRA continue to grow tax-deferred, with distributions taxed as ordinary income in retirement. If you roll over pre-tax 401(k) funds into a Roth IRA, the amount converted will be subject to income tax in the year of the conversion, but qualified distributions from the Roth IRA in retirement will be tax-free.

Taking a cash distribution means directly withdrawing funds from your 401(k). When you take a cash distribution from a traditional 401(k), the entire amount is generally taxed as ordinary income in the year you receive it. If under age 59½, withdrawals are typically subject to an additional 10% early withdrawal penalty. There are limited exceptions to this penalty, such as separation from service at age 55 or later, certain unreimbursed medical expenses, or total and permanent disability.

For direct distributions, the plan administrator generally withholds 20% for federal income taxes. This mandatory withholding applies even if you intend to complete an indirect rollover. In an indirect rollover, you receive funds directly and have 60 days to deposit them into another eligible retirement account to avoid taxation and penalties. If you fail to redeposit the full amount within this 60-day window, the distribution becomes taxable and may incur the 10% early withdrawal penalty if you are under age 59½.

Implementing Your 401(k) Decision

After deciding on your 401(k) option, execute that decision. This requires engaging with your former plan administrator and potentially a new financial institution.

Contact your former 401(k) plan administrator. This can be done online, by phone, or via mail. The administrator will provide specific instructions and required paperwork for processing a distribution or rollover.

For a direct rollover, whether to a new employer’s 401(k) or an IRA, you will typically provide the former plan administrator with the details of the receiving account. This includes the name and address of the new financial institution and the new account number. The former plan administrator then sends the funds directly to the new custodian, often via a check made payable to the new institution for the benefit of your account. This method ensures the funds are not paid to you personally, thus avoiding the mandatory 20% federal tax withholding and any potential early withdrawal penalties.

If you opt for a cash distribution, request it from your former plan administrator. They will process the withdrawal and issue a check or direct deposit, minus the mandatory 20% federal income tax withholding. You will receive the remaining 80% of your funds. It is important to remember that this 20% withholding is a prepayment of your tax liability, and your actual tax due may be higher or lower depending on your overall income for the year.

After submitting your request, follow up to ensure the process is proceeding as expected. For rollovers, confirmation of the transfer should be provided by both the sending and receiving institutions within a reasonable timeframe, often a few weeks. If a cash distribution occurs, you can expect to receive IRS Form 1099-R from your former plan administrator by January 31 of the year following the distribution. This form reports the amount of the distribution and any taxes withheld, and it is necessary for filing your federal income tax return for that year.