What Should I Do With My 401k When I Change Jobs?

When changing jobs, deciding the fate of your former employer’s 401(k) plan is a key financial consideration. Understanding the various choices available and their implications is important for making an informed decision that aligns with your long-term financial goals. The path you choose can impact the accessibility of your funds, the types of investments you can hold, and the tax treatment of your savings.

Understanding Your Choices

When you leave a job, you generally have four primary options for your old 401(k) account. Each choice carries distinct advantages and disadvantages regarding investment control, fees, and tax consequences.

One option is to leave your funds in the old employer’s 401(k) plan. This choice offers simplicity, as no immediate action is required. However, you will no longer be able to contribute to the plan, and investment options may be limited. Some plans may charge higher fees for former employees, or may even force out accounts with small balances by issuing a check or rolling them into an IRA.

Alternatively, you could roll over your funds into your new employer’s 401(k) plan. This option allows for consolidation of your retirement savings, making them easier to track and manage in one location. Your new plan might offer competitive fees and a different selection of investment options, potentially aligning better with your current financial objectives. However, you will be subject to the investment choices and rules of the new plan, which may or may not be as flexible as an Individual Retirement Account (IRA).

A third choice is to roll over your 401(k) into an Individual Retirement Account (IRA). This option provides a wider array of investment choices, including stocks, bonds, mutual funds, and exchange-traded funds, offering greater control and flexibility over your portfolio. IRAs are not tied to an employer, providing stability regardless of future job changes, and can also offer lower fees compared to some employer-sponsored plans. This flexibility allows you to tailor your retirement portfolio to your specific goals and risk tolerance.

Finally, you could choose to cash out your 401(k) by taking a lump sum distribution. While this provides immediate access to funds, it comes with significant financial penalties and tax implications. The distribution is taxed as ordinary income, and if you are under age 59½, an additional 10% early withdrawal penalty applies. This option can severely diminish your retirement savings and should be considered only as a last resort due to its substantial costs.

Getting Ready for a Rollover

Preparing for a 401(k) rollover involves understanding the specific mechanisms of transferring funds and gathering necessary documentation. The two primary methods for moving funds are direct rollovers and indirect rollovers, each with distinct procedural and tax implications. A direct rollover involves the transfer of funds directly from your old plan administrator to your new retirement account custodian. This method is preferred because it avoids immediate tax withholding and potential penalties.

In contrast, an indirect rollover means you receive the funds yourself, as a check made out to you. If you choose this method, you have a 60-day window from the date you receive the distribution to deposit the entire amount into a qualified retirement account to avoid taxes and penalties. A key aspect of an indirect rollover from a 401(k) is the mandatory 20% federal income tax withholding by the plan administrator. To complete the rollover and avoid the distribution being fully taxed and potentially penalized, you must deposit the full amount into the new account, making up the withheld difference from other sources. The withheld amount can be recovered as a tax credit when you file your tax return, provided the full rollover is completed within the 60-day period.

To initiate a rollover, you will need to contact your former employer’s 401(k) plan administrator. They will provide the necessary forms and instructions for initiating the distribution. This includes gathering essential details such as your account number and the specific type of distribution forms required for a rollover. You may also need to specify whether you want a direct or indirect rollover.

Simultaneously, you should prepare information for your new account, whether it is a new employer’s 401(k) or an IRA. If rolling into an IRA, you will need to open the IRA account with a financial institution if you do not already have one. Obtain the new account number and routing information, along with any specific forms the receiving institution requires for accepting rollover funds. Institutions can provide a “letter of acceptance” that your old plan administrator might request.

With all information gathered, accurately complete the distribution forms from your old plan and any receiving forms for the new account. Ensure all names, account numbers, and rollover instructions are precise to prevent delays or complications. Double-checking these details can help facilitate a smooth transfer of your retirement assets.

Steps to Move Your Funds

Once preparatory steps are complete and you have gathered the necessary information and forms, the next phase involves the actual movement of your funds. The process will vary depending on whether you opt for a direct rollover, an indirect rollover, or choose to cash out your account.

For a direct rollover, the most straightforward and tax-efficient method, you will submit the completed distribution forms from your old plan to its administrator. These forms will instruct them to send your funds directly to your new IRA custodian or your new employer’s 401(k) plan. The funds are transferred electronically or via a check made payable to the new financial institution, not to you personally. This ensures the money never passes through your hands, thus avoiding mandatory tax withholding and the 60-day rule associated with indirect rollovers. Direct rollovers take between three to seven business days to process.

If you selected an indirect rollover, your old plan administrator will issue a distribution check made out to you, with 20% of the taxable amount already withheld for federal income taxes. Upon receiving this check, you must deposit the full amount of the distribution, including the 20% that was withheld, into an eligible retirement account within 60 calendar days. Failing to meet this deadline means the entire distribution will be treated as a taxable withdrawal, and if you are under age 59½, it will also be subject to the 10% early withdrawal penalty. You will need to use other funds to cover the 20% withheld amount to ensure the entire original balance is rolled over, and you can reclaim the withheld taxes as a credit when you file your income tax return.

Should you decide to cash out your 401(k), you will submit a request for a full distribution to your former plan administrator. They will process the withdrawal, withhold the required federal income taxes and any applicable state taxes. The remaining funds will then be sent to you via check or direct deposit. This action permanently removes the funds from a tax-advantaged retirement account, making them immediately taxable and potentially subject to the 10% early withdrawal penalty if you are under age 59½.

After initiating any of these processes, monitor the transfer of funds. You can expect to receive confirmation notices from both your old plan administrator and the new receiving institution. Your old plan administrator will also issue Form 1099-R by January 31 of the year following the distribution. This form details the amount of the distribution and any taxes withheld, and you will need it for filing your tax return.