What Should I Do With My 401k After I Leave My Job?

Leaving a job requires careful consideration for your 401(k) retirement savings. Your accumulated 401(k) is a significant asset, and deciding its future requires thought to ensure continued growth and tax compliance. Understanding the options for your former employer’s 401(k) is crucial. Each choice has distinct implications for access, investment control, and tax treatment, helping you align with your financial strategy.

Maintaining Your Funds in the Former Employer’s Plan

You can leave your 401(k) funds in your former employer’s retirement plan. Your savings continue growing tax-deferred, with taxes paid only upon withdrawal in retirement. The plan administrator will continue to manage your account, providing statements and access to your investment details.

This option is usually available if your balance exceeds $5,000. If below this, the plan may automatically distribute funds or roll them into an Individual Retirement Account (IRA) on your behalf.

While simple, investment options might be limited, and you remain subject to the plan’s fee structure. Required Minimum Distributions (RMDs) generally apply to these funds starting at age 73.

Transferring to a New Employer’s Retirement Plan

Moving your retirement savings to a new employer’s qualified plan, like a 401(k) or 403(b), is a rollover. This keeps your funds tax-deferred until retirement withdrawals.

There are two main rollover methods:
Direct Rollover: Funds transfer directly from your former plan to your new plan. This avoids immediate tax withholding or penalties.
Indirect Rollover: Funds are first distributed to you, and you then have 60 days to deposit the full amount into your new plan. Your former employer’s plan must withhold 20% for federal taxes. To avoid taxes and penalties, you must deposit the entire original distribution, including the 20% that was withheld, within 60 days, potentially requiring you to use other funds to make up the difference. Failure to do so means the distribution is treated as taxable income, and if you are under age 59½, it may incur an additional 10% early withdrawal penalty.

When considering a rollover, evaluate investment options, administrative fees, and loan availability. Qualified employer-sponsored plans generally receive strong creditor protection under the Employee Retirement Income Security Act of 1974 (ERISA), shielding savings from most creditors.

Moving Funds to an Individual Retirement Account (IRA)

Transferring your 401(k) to an Individual Retirement Account (IRA) offers greater investment flexibility and control. IRAs typically provide a broader selection of investment products, such as individual stocks, bonds, and a wider array of mutual funds and exchange-traded funds, compared to many employer plans. This expanded choice can allow for more personalized portfolio construction.

When rolling over pre-tax 401(k) funds, consider a Traditional IRA or a Roth IRA. A Traditional IRA maintains tax-deferred status, with taxes paid on withdrawals in retirement. This is generally a non-taxable event if executed as a direct rollover.

Converting to a Roth IRA is a taxable event; the converted amount is added to your income in the conversion year. The main advantage of a Roth IRA is that qualified withdrawals in retirement are entirely tax-free, provided the account is open for at least five years and you are age 59½ or older.

As with 401(k) rollovers, an IRA rollover should be direct to avoid mandatory tax withholding and penalties. If you choose an indirect rollover, the 20% federal tax withholding and 60-day rules apply. Choosing a custodian for your IRA, such as a brokerage firm or bank, is an administrative step that determines where your account will be held and managed.

Traditional IRAs are subject to RMDs, generally starting at age 73. Original Roth IRA owners are not subject to RMDs during their lifetime.

Withdrawing Your 401(k) Balance

Cashing out your 401(k) balance is generally not recommended due to significant financial consequences. This action can deplete retirement savings and trigger substantial tax liabilities and penalties.

When you cash out a traditional 401(k), the entire withdrawal is taxed as ordinary income. This means the distribution is added to your other income for the year, and your marginal tax rate applies. If you are under age 59½, an additional 10% early withdrawal penalty typically applies.

If you receive a direct distribution rather than a direct rollover, your former employer’s plan must withhold 20% for federal income taxes. This reduces the amount received, and you remain responsible for any remaining tax liability and the 10% penalty if applicable.

Exceptions to the 10% early withdrawal penalty exist, though the distribution remains subject to ordinary income tax. These include separation from service at age 55 or older, total and permanent disability, or distributions for unreimbursed medical expenses exceeding 7.5% of your adjusted gross income. Cashing out forfeits years of potential tax-deferred growth, hindering long-term financial security.