What Happens to Your 401(k) When You Leave a Job?
Leaving a job means decisions for your 401(k). Learn the paths available, their financial impact, and how to manage your retirement assets.
When an individual leaves their employment, a significant decision arises concerning their 401(k) retirement savings plan. This employer-sponsored account requires careful consideration upon a job change. The vested funds have substantial financial implications for future management.
Your Main Choices for an Existing 401(k)
Individuals have several pathways for their 401(k) funds after separating from an employer. One option is to leave funds in the former employer’s plan, often permitted if the balance exceeds a certain threshold (e.g., $5,000 or $7,000). Some plans may automatically roll over smaller balances or cash them out.
Another common approach is to roll over the funds into a new employer’s 401(k) plan. This is contingent on the new employer offering a 401(k) and their plan accepting incoming rollovers. Consolidating retirement savings into one active account can simplify financial management.
Many individuals roll over their 401(k) into an Individual Retirement Account (IRA). This transfers funds from the employer plan to a self-directed Traditional or Roth IRA, which generally offers a broader selection of investment options.
A final option is to cash out the 401(k) funds, taking a lump-sum distribution. While providing immediate access, this often carries significant financial drawbacks.
Understanding the Implications of Each Choice
Each decision regarding a former 401(k) carries distinct implications for taxes, investment control, fees, access to funds, and creditor protection. Leaving funds in the former employer’s plan allows continued tax-deferred growth, but new contributions are not possible. Investment options and fees remain subject to the former plan’s rules, which might be limited or change over time.
Rolling over funds into a new employer’s 401(k) plan consolidates savings, continues tax-deferred growth, and may allow new employer matching contributions. The new plan governs investment choices and fees. This option generally maintains Employee Retirement Income Security Act (ERISA) protection, shielding funds from creditors.
Transferring funds to an IRA (Traditional or Roth) provides a wider array of investment choices, offering greater control over strategy. For a Traditional 401(k) rolled into a Traditional IRA, funds continue tax-deferred growth, with distributions taxed as ordinary income in retirement. If a Traditional 401(k) is converted to a Roth IRA, the converted amount is subject to income tax in the year of conversion, but qualified withdrawals in retirement are tax-free.
Roth IRAs do not have Required Minimum Distributions (RMDs) during the original owner’s lifetime. Traditional IRAs and 401(k)s require RMDs to begin at age 73, increasing to 75 in 2033. Failure to take an RMD can result in a 25% excise tax on the amount not withdrawn, potentially reduced to 10% if corrected promptly. While ERISA protection is generally lost when funds move from a 401(k) to an IRA, IRAs receive some federal creditor protection in bankruptcy up to a certain limit, and state laws may offer additional protection.
Cashing out a 401(k) is the most financially detrimental choice. Distributions from a traditional 401(k) are immediately subject to ordinary income tax. If under age 59½, a 10% early withdrawal penalty applies to the taxable portion, in addition to federal and state income taxes.
Limited exceptions to the 10% penalty exist, such as separation from service at age 55 or older or certain medical expenses. This option also forfeits future tax-deferred growth, impacting long-term retirement savings.
Steps to Implement Your Decision
Once a decision is made regarding your former 401(k), the implementation process requires specific actions. For rollovers to a new employer’s 401(k) or an IRA, a direct rollover (trustee-to-trustee transfer) is the most secure method. Funds move directly from the former plan administrator to the new custodian, avoiding direct receipt by the individual. Contact the former plan administrator to initiate this, providing new account details.
A direct rollover is important because if funds are paid directly to you, the plan administrator must withhold 20% for federal income taxes. While you can still complete the rollover by depositing the full amount (including the withheld 20%) into a new retirement account within 60 days, you would need other funds to cover the withheld portion until tax filing. If the entire amount is not rolled over within 60 days, the unrolled portion becomes a taxable distribution subject to income tax and potential early withdrawal penalties.
To cash out funds, contact the former plan administrator to request a distribution. They will provide necessary forms. The plan will likely withhold taxes, and you may receive a net amount after deductions.
If leaving funds in the old plan, no active steps are typically required, especially if the balance exceeds the plan’s minimum threshold for forced distributions. However, confirm with the former plan administrator that the account remains active and accessible. Ensure you have current contact information and online account access to monitor investments and fees. Gathering all relevant account information before separating from employment can streamline any chosen process. The entire rollover process can take several weeks.