What Should I Do With My 401k When I Leave a Job?

Transitioning between jobs involves important financial decisions regarding your 401(k) retirement savings. The choices made about these funds influence your long-term financial security and growth. Understanding the available options and their implications is essential for making an informed decision that aligns with your retirement planning.

Keeping Your 401(k) with Your Former Employer

You can leave your 401(k) funds in your former employer’s plan, especially if your account balance meets the plan’s minimum requirements, which often range from $5,000 to $7,000. This allows your money to continue growing on a tax-deferred basis. Federal law provides broad protection against creditors for funds held in a 401(k).

However, keeping funds with a former employer has disadvantages. You may face limited investment choices and cannot make new contributions. Higher administrative fees are possible, and managing multiple accounts from different past employers can become complex. If your balance is below a certain threshold, typically $1,000, your former employer might automatically cash out your account. For balances between $1,000 and $7,000, they might roll it into an IRA.

Before deciding, contact your former plan administrator to confirm this option is available. Inquire about current investment options, the fee schedule, and any rules regarding leaving funds in the plan. This information helps assess if the plan meets your investment needs and cost expectations.

Rolling Over to a New Employer’s 401(k)

Transferring your old 401(k) to your new employer’s plan, a direct rollover, consolidates your retirement assets. This process moves funds directly from your old plan administrator to your new one, so you never take possession of the money. Consolidating funds simplifies management and provides a clearer picture of your overall retirement savings.

Advantages include continued tax-deferred growth and potential for higher contribution limits compared to IRAs. Your funds also retain creditor protection under federal law. However, investment options are limited to those offered by your new employer’s plan, which might not align with your preferences or offer competitive fees. Not all employer plans accept rollovers from previous plans.

To execute a direct rollover, confirm with your new employer’s plan administrator if they accept rollovers and understand their procedures, investment options, and fee structure. Then, contact your former 401(k) plan administrator to initiate the direct rollover. You will complete forms from both providers, ensuring funds are sent directly to your new plan, which helps avoid tax withholding and penalties.

Rolling Over to an IRA

Rolling over your 401(k) to an Individual Retirement Account (IRA) is a popular option due to its flexibility. This choice provides access to a broader selection of investment products (e.g., stocks, bonds, mutual funds, ETFs), allowing for greater portfolio customization. IRAs can also offer lower fees than certain 401(k) plans, though this varies by provider and investment choice.

When considering an IRA rollover, decide between a Traditional IRA and a Roth IRA. Rolling pre-tax 401(k) funds to a Traditional IRA maintains their tax-deferred status, with taxes paid upon withdrawal in retirement. Converting pre-tax 401(k) funds to a Roth IRA requires paying income tax on the converted amount in the year of conversion. While this creates an immediate tax liability, qualified withdrawals from a Roth IRA in retirement are entirely tax-free, offering significant future tax benefits.

Despite the advantages, IRA rollovers have drawbacks. Unlike some 401(k)s, IRAs do not offer loan provisions. Additionally, while creditor protection for IRAs is substantial under federal law, it can vary by state, potentially offering less comprehensive protection than employer-sponsored 401(k)s in some instances.

The preferred method for this transfer is a direct rollover. In this process, your former 401(k) administrator sends the funds directly to your chosen IRA custodian, ensuring the money never passes through your hands. This direct transfer avoids mandatory tax withholding and potential penalties. You will open the new IRA first, then work with both the old 401(k) provider and the new IRA custodian to complete the necessary paperwork.

An indirect rollover, where funds are paid directly to you, is not recommended due to risks. If you receive the funds, your plan administrator must withhold 20% for federal income tax. You have 60 days from receipt to deposit the full amount, including the 20% withheld, into an eligible IRA or another qualified retirement plan. If the full amount is not redeposited within this 60-day window, the withdrawn amount is a taxable distribution and may be subject to income tax and a 10% early withdrawal penalty if you are under age 59½.

Taking a Direct Distribution

Taking a direct distribution, or “cashing out,” your 401(k) means withdrawing funds directly as taxable income. This option is a last resort due to significant penalties and long-term consequences. The entire distribution is taxed as ordinary income, adding to your taxable income for the year and potentially pushing you into a higher tax bracket.

If you are under age 59½, the withdrawn amount is subject to an additional 10% early withdrawal penalty. This penalty applies unless specific exceptions are met, such as separation from service at age 55 or later from the employer sponsoring the plan, distributions due to total and permanent disability, certain unreimbursed medical expenses, or distributions made as part of substantially equal periodic payments (SEPP). Qualified domestic relations orders (QDROs) or qualified birth or adoption expenses can also be exempt from the penalty.

Even if an exception applies, the plan administrator must withhold 20% of the distribution for federal income tax. This mandatory withholding means you receive only 80% of your funds, and you must cover any additional taxes owed when filing your tax return. The most significant long-term consequence of cashing out is the loss of future tax-deferred growth, severely impacting your retirement savings potential.

To request a direct distribution, contact your former 401(k) plan administrator and complete their distribution forms. Upon receiving funds, you will receive IRS Form 1099-R, reporting the distribution amount, taxes withheld, and withdrawal type. This form is essential for accurate income tax reporting.