What Happens to Your 401k If You Quit?

When employment changes, understanding what happens to your 401(k) plan is important. These employer-sponsored plans represent a substantial portion of many individuals’ financial preparation for retirement. The choices made can have lasting effects on your long-term financial security and immediate tax obligations.

Your 401k Options After Quitting

Upon leaving a job, you have several choices for managing funds in your former employer’s 401(k) plan.
Leave funds in the existing plan: This is an option if the plan administrator permits it and your balance meets minimum requirements. Many plans allow balances above $5,000 to remain, while smaller balances might be automatically distributed or rolled over to an IRA.
Roll over to a new employer’s 401(k): This is possible if your new company offers a plan that accepts incoming rollovers. This consolidates your retirement savings, simplifying management. The new employer’s plan administrator determines rules for accepting rollovers.
Roll over to an Individual Retirement Account (IRA): This offers greater control over investment choices and a wider range of options than an employer-sponsored plan. You can choose between a Traditional IRA (tax-deferred growth) or a Roth IRA (tax-free withdrawals in retirement).
Take a cash distribution: This involves directly withdrawing funds from your 401(k) account. While it provides immediate access to money, it comes with significant tax implications and penalties.

Tax and Penalty Outcomes

Leaving funds in your former employer’s plan or directly rolling them over to a new 401(k) or an IRA avoids immediate income tax and penalties. A direct rollover moves money directly from the old plan to the new account without passing through your hands. This keeps the funds’ tax-deferred status intact, preventing them from being considered a taxable distribution.

Taking a cash distribution from your 401(k) results in tax consequences. The entire amount withdrawn is subject to ordinary income tax. If you are under age 59½, an additional 10% early withdrawal penalty applies.

There are exceptions to the 10% early withdrawal penalty, though the distribution may still be subject to ordinary income tax. These exceptions include:
Withdrawals due to total and permanent disability.
Certain unreimbursed medical expenses exceeding a percentage of adjusted gross income.
Qualified higher education expenses.
Distributions as part of a series of substantially equal periodic payments (SEPPs).
Up to $10,000 for a first-time home purchase.
Qualified military reservist distributions.

When an eligible rollover distribution is not directly rolled over, 20% federal income tax withholding is mandated. If you choose an indirect rollover, where a check is issued to you, only 80% of the amount will be received. The remaining 20% is sent to the IRS as withholding. You have 60 days from receiving the funds to deposit the full amount, including the 20% withheld, into an eligible retirement account. This completes the rollover and avoids taxation and penalties. If the full amount is not rolled over within this 60-day window, the unrolled portion becomes a taxable distribution subject to income tax and potentially the 10% early withdrawal penalty.

Executing Your Decision

Implementing your chosen strategy begins by contacting your former employer’s plan administrator. This could be a financial institution like Fidelity, Vanguard, or Principal. Their contact information is usually on your most recent statement. The plan administrator provides necessary forms and instructions specific to your former plan’s policies.

For a direct rollover to a new employer’s 401(k) or an IRA, coordinate between your former plan administrator and the administrator of your new plan or IRA custodian. You will complete a rollover request form from your old plan, indicating the receiving institution and account number. Funds are then transferred directly between the financial institutions, often electronically or via a check payable to the new plan or custodian.

If you opt for an indirect rollover, the former plan administrator will issue a check payable to you for the distributed amount, less the mandatory 20% federal tax withholding. You must deposit the full amount of the distribution, including the 20% that was withheld, into your new IRA or qualified retirement plan within 60 calendar days of receiving the funds. You will need to use other funds to cover the amount withheld to complete the full rollover.

For those choosing a cash distribution, submit a withdrawal request form to the former plan administrator. They will issue a check or directly deposit funds into your bank account, minus any applicable taxes and penalties. You will later receive Form 1099-R, which reports the distribution to the IRS for tax purposes. If you leave funds in the former employer’s plan, no specific action is required, but confirm with the plan administrator that your account remains active and accessible.