What to Do With a 401(k) After Leaving a Job

Leaving a job involves practical considerations, especially regarding your 401(k) retirement savings. This account, accumulated through contributions and employer matches, represents a substantial portion of many individuals’ financial security. Making an informed choice is important for maintaining and growing your retirement nest egg, requiring careful consideration of financial goals, investment preferences, and future plans.

Leaving Funds in the Former Employer’s Plan

One option is to leave 401(k) funds within the former employer’s plan. This allows money to grow tax-deferred, with earnings and contributions untaxed until retirement withdrawal. Investment options, however, remain limited to those offered within the former plan, potentially fewer than other retirement vehicles.

Employers generally permit former employees to keep their 401(k) if the vested balance exceeds certain thresholds. Balances under $1,000 may be automatically cashed out or rolled into an Individual Retirement Account (IRA). For balances between $1,000 and $5,000, employers may “force out” funds by automatically rolling them into an IRA. If the vested balance is $5,000 or more, or up to $7,000 in some cases, you are typically allowed to keep the funds in the plan.

Leaving funds with a former employer can create an administrative burden, especially with multiple 401(k) accounts. Tracking investments, monitoring performance, and managing a diversified portfolio across different providers can be challenging. Despite this, 401(k) plans generally offer creditor protection under the Employee Retirement Income Security Act of 1974 (ERISA). This federal law shields assets in most employer-sponsored plans from creditors, civil lawsuits, and bankruptcy, a protection that continues as long as assets remain within the ERISA-qualified plan.

Rolling Over to an Individual Retirement Account

Rolling over a 401(k) into an Individual Retirement Account (IRA) transfers funds from a former employer’s plan. This offers greater control and flexibility over retirement savings. An IRA rollover allows funds to continue benefiting from tax-deferred growth, similar to a 401(k).

Two primary IRA types exist for rollovers: Traditional and Roth. Rolling over to a Traditional IRA maintains tax-deferred status, with distributions taxed as ordinary income in retirement. Converting a traditional 401(k) to a Roth IRA requires paying taxes on the converted amount, but qualified withdrawals in retirement are tax-free. This conversion might appeal to those anticipating a higher tax bracket in retirement.

Rollovers can be direct or indirect. A direct rollover, the more common method, involves the 401(k) administrator sending funds directly to the IRA custodian. This avoids immediate tax implications or withholding.

In contrast, an indirect rollover distributes funds to the individual, who then has 60 days to deposit them into an IRA. Failure to re-deposit within this window makes the distribution taxable as ordinary income and may incur a 10% early withdrawal penalty if under age 59½. Indirect rollovers typically trigger a mandatory 20% federal income tax withholding, which the individual must make up to complete the full rollover.

IRAs generally offer a broader range of investment options than most employer-sponsored 401(k) plans, including stocks, bonds, mutual funds, and exchange-traded funds. This flexibility allows individuals to tailor their investment strategy to their financial goals and risk tolerance. To initiate a direct rollover, contact your former 401(k) administrator and provide new IRA account details. The administrator then directly transfers funds, simplifying the process and avoiding potential tax issues.

Transferring to a New Employer’s 401(k)

Another option is to transfer 401(k) funds to a new employer’s plan. This “rollover” consolidates retirement savings into a single account, simplifying financial management. Transferring funds depends on whether the new plan accepts rollovers. Many employer-sponsored plans permit such transfers, but confirm eligibility with the new plan administrator.

Transferring funds to a new 401(k) allows money to continue growing tax-deferred, maintaining its tax-advantaged status. Consolidating funds means current contributions and the rolled-over amount benefit from higher 401(k) contribution limits compared to IRAs. This option also provides access to plan-specific features, such as 401(k) loans, though loans are typically only available to active employees.

An advantage of keeping funds within a 401(k) framework is continued creditor protection provided by ERISA. Assets in an ERISA-qualified 401(k) plan are generally protected from creditors, civil lawsuits, and bankruptcy, offering protection for retirement savings. This federal protection remains intact when funds transfer between ERISA-qualified plans. To initiate this transfer, contact your new employer’s 401(k) plan administrator for forms and guidance for a direct rollover.

Taking a Cash Distribution

Taking a cash distribution, or “cashing out,” a 401(k) involves directly receiving funds. While providing immediate liquidity, it is generally the least advisable option due to financial drawbacks.

A traditional 401(k) distribution is typically treated as ordinary income for tax purposes. The full amount will be subject to federal and often state income tax, reducing the amount received. If under age 59½, an additional 10% early withdrawal penalty usually applies.

When taking a direct cash distribution, the plan administrator generally withholds 20% for federal income tax. This mandatory withholding may not cover the full tax liability, and you may owe more when filing your tax return. Cashing out incurs immediate taxes and penalties, permanently removing funds from a tax-advantaged retirement account. This forfeits future tax-deferred growth, depleting long-term retirement security. To request a cash distribution, contact your former 401(k) plan administrator and complete withdrawal forms.