What to Do With a 401k When Leaving a Job: Your Options

When leaving a job, understanding what to do with your accumulated 401(k) retirement savings is a significant financial decision. These funds represent a portion of your future financial security, and your choices can have lasting impacts on your retirement goals. Navigating these options carefully helps preserve your savings and ensures they continue to grow effectively.

Overview of Your Choices

Upon separating from an employer, you generally have a few distinct options for handling your 401(k) funds, including leaving the money within your former employer’s retirement plan, provided certain conditions are met. A second common choice involves transferring the funds into your new employer’s 401(k) plan, consolidating your retirement savings. Another widely utilized option is rolling over your 401(k) into an Individual Retirement Account (IRA), which offers a broad range of investment choices. The final option is taking a direct cash withdrawal of your funds. Each of these paths carries different implications regarding access, investment flexibility, fees, and tax consequences.

Keeping Funds with Your Previous Employer’s Plan

One option for your 401(k) after leaving a job is to leave the funds in your former employer’s plan. This choice is typically available if your account balance exceeds a certain amount, commonly set at $5,000. If your balance is below this threshold, the plan administrator may have the right to automatically distribute your funds, often by rolling them into an IRA for you or issuing a check.

When considering this path, evaluate the ongoing administrative fees associated with the old plan, which can sometimes be higher than those in an IRA or a new employer’s plan. You should also assess the range and quality of investment options offered by the previous plan to ensure they align with your current financial strategy. To confirm eligibility and understand any associated costs, you should contact your former employer’s human resources department or the plan administrator directly, requesting information on fee schedules and investment performance.

In many cases, if your balance meets the minimum threshold, no specific action is required to keep the funds in the plan, as they will remain there by default. However, communicate with the plan administrator to confirm your decision and ensure there are no required forms or online confirmations. This helps avoid any unintended distributions and ensures your funds remain secure within the plan.

Transferring to a New Employer’s 401(k)

Moving your 401(k) balance to a new employer’s plan can simplify managing your retirement savings. Before initiating this process, confirm that your new employer’s 401(k) plan accepts rollovers from previous plans, as eligibility rules and waiting periods can vary. Consolidating funds can streamline your financial oversight, potentially reduce fees if the new plan offers lower costs, and provide access to new investment options.

There are two primary methods for moving funds: a direct rollover and an indirect rollover. A direct rollover involves the funds being transferred directly from your old plan administrator to your new plan administrator, avoiding any personal handling of the money. With an indirect rollover, a check for your 401(k) balance is made payable to you, the individual, and you then have 60 days from the date of receipt to deposit it into your new 401(k) or another eligible retirement account. If you choose an indirect rollover, the former plan is required by the IRS to withhold 20% of the distribution for federal income taxes, even if you intend to roll over the full amount.

To initiate a direct rollover, you will contact your former 401(k) plan administrator and request a direct transfer to your new employer’s plan. You will typically need to provide your new plan’s name, account number, and custodian details. The check will then be issued directly to the new plan’s custodian, ensuring no tax withholding occurs. For an indirect rollover, once you receive the check, you must deposit the full amount, including the 20% withheld, into your new 401(k) within the 60-day window to avoid taxes and penalties. After the transfer, confirm with both the old and new plan administrators that the funds have been successfully moved and are properly invested within your new account.

Rolling Over to an Individual Retirement Account

Rolling over your 401(k) into an Individual Retirement Account (IRA) offers considerable flexibility in managing your retirement savings. You can choose to roll funds into a Traditional IRA, where pre-tax contributions grow tax-deferred, meaning taxes are paid upon withdrawal in retirement. Alternatively, you might consider converting pre-tax 401(k) funds into a Roth IRA, where contributions are made after-tax, but qualified withdrawals in retirement are tax-free. Converting to a Roth IRA triggers immediate taxation on the converted amount, as it moves from a tax-deferred to a tax-free growth vehicle.

Selecting an IRA custodian, such as a bank, brokerage firm, or mutual fund company, is a significant step, and factors like account fees, the breadth of investment options, customer service quality, and available research tools should guide your decision. You will need to provide your former 401(k) plan with your account number and beneficiary information to facilitate the rollover. Rollovers to IRAs can be direct or indirect, with the same 60-day rule applying to indirect rollovers to avoid tax implications.

Open a new IRA account with your chosen custodian. For a direct rollover, instruct your former 401(k) plan administrator to send the funds directly to your new IRA custodian, ensuring the check is made payable to the custodian “FBO [Your Name].” If you receive a check made out to you, this is an indirect rollover, and you must deposit the full amount into your IRA within 60 days to avoid it being treated as a taxable distribution. For those considering a Roth conversion, after the funds are in a Traditional IRA, you can then instruct your IRA custodian to convert all or a portion of the funds to a Roth IRA, understanding that this action will result in taxable income for the year of conversion. Following the rollover or conversion, confirm the transfer with both parties and review your investment allocations and beneficiary designations within the new IRA.

Taking a Cash Withdrawal

Opting for a cash withdrawal from your 401(k) is generally the least advisable choice due to significant financial consequences. The entire withdrawn amount becomes subject to ordinary income tax at your marginal tax rate for that year. Furthermore, if you are under age 59½, the distribution is typically subject to an additional 10% early withdrawal penalty imposed by the Internal Revenue Service (IRS).

There are specific exceptions to this 10% penalty, such as separation from service at age 55 or older, disability, or distributions for certain unreimbursed medical expenses exceeding 7.5% of adjusted gross income. Other exceptions include qualified higher education expenses or substantially equal periodic payments. Even if an exception applies, the withdrawal amount remains subject to ordinary income tax. The plan administrator is also required to withhold 20% of the distribution for federal income taxes, which is an upfront payment and not the total tax liability.

To request a cash distribution, you will typically complete a distribution request form provided by your former 401(k) plan administrator. After processing, you will receive the funds, either via check or direct deposit, and a Form 1099-R will be issued to you by the plan administrator, reporting the distribution to the IRS. This form will detail the gross distribution, the taxable amount, and any federal income tax withheld. Taking a cash withdrawal significantly depletes your retirement savings, potentially hindering your long-term financial security and incurring substantial immediate tax burdens.