What to Do With a 401(k) When You Leave a Company?

When transitioning from one employer to another, managing your 401(k) retirement savings requires a significant financial decision. Making an informed choice is important for preserving and enhancing your retirement nest egg. Understanding the available options and their considerations can help navigate this process effectively.

Your 401(k) Options Upon Leaving a Company

Upon departing from an employer, several distinct paths become available for managing a 401(k) account. Each option offers a different approach to handling these accumulated retirement funds.

• Leaving the funds within the former employer’s 401(k) plan.
• Transferring the funds to a new employer’s 401(k) plan.
• Moving retirement savings into an Individual Retirement Account (IRA).
• Taking a lump-sum distribution, effectively cashing out the funds.

Understanding the Financial and Tax Impact of Each Choice

Each decision regarding a 401(k) after leaving a company carries specific financial and tax implications. Understanding these consequences is important for making a choice that supports long-term financial well-being. The impact can vary significantly depending on the chosen path, affecting growth potential, fees, and immediate tax obligations.

Leaving funds in the former employer’s plan might seem convenient, requiring no immediate action. However, this option can come with drawbacks such as administrative fees, which may be higher for former employees, and limited investment choices. Individuals no longer contribute to the account, and the former employer can change plan administrators or investment options. For balances below $7,000, employers may automatically roll the funds into an IRA or even cash them out.

Rolling over funds to a new employer’s 401(k) plan allows for continued tax-deferred growth and consolidation of retirement savings in one place. This can simplify financial management by having all retirement assets under a single plan. The new plan might offer different investment options, and it is prudent to compare fees and available investments with the old plan.

Transferring funds to an Individual Retirement Account (IRA) offers greater control over investments and more diverse options than many employer-sponsored plans. This flexibility can allow for a more personalized investment strategy. IRAs can also consolidate multiple retirement accounts, simplifying management and tracking.

There are two primary methods for rolling over funds to an IRA. A direct rollover, also known as a trustee-to-trustee transfer, involves the former 401(k) administrator sending funds directly to the new IRA custodian. This method avoids immediate tax withholding and potential penalties, ensuring the full amount is transferred without the account holder physically receiving the funds.

Alternatively, an indirect rollover, or 60-day rollover, involves the 401(k) administrator issuing a check for the distribution directly to the participant. The plan administrator is required to withhold 20% of the taxable amount for federal income taxes. The participant then has a strict 60-day window from the date of receipt to deposit the entire distribution, including the 20% that was withheld, into a new IRA. Failure to deposit the full amount within this 60-day period means the unrolled portion becomes a taxable distribution, and if the individual is under age 59½, it may also incur a 10% early withdrawal penalty. To fully roll over the amount, the individual must use other funds to replace the 20% that was withheld.

Cashing out a 401(k) by taking a lump-sum distribution is generally the least advisable option due to significant financial and tax consequences. The entire distribution is treated as ordinary income and is subject to federal income tax. If the individual is under age 59½, an additional 10% early withdrawal penalty usually applies. This option diminishes retirement savings by removing funds that would have continued to grow tax-deferred.

Steps for Initiating Your Chosen Action

Once a decision is made regarding the disposition of a 401(k) after leaving an employer, initiating the chosen action requires specific procedural steps. These steps ensure the smooth transfer or distribution of funds.

For a direct rollover, either to a new employer’s 401(k) or an IRA, contact the administrator of the former employer’s 401(k) plan. Provide the new account details, including the name of the new custodian and the account number. Specify that a direct rollover, or trustee-to-trustee transfer, is desired to ensure the funds move directly between financial institutions. The former plan administrator may require specific forms or a letter of acceptance from the new custodian. Verify the transfer after a few business days to confirm the funds have been successfully received.

If an indirect rollover is chosen, the former 401(k) administrator will issue a check made payable to the participant. This check will reflect the distribution amount minus the 20% federal tax withholding. Upon receiving this check, the participant must deposit the full amount, including the withheld 20%, into a new eligible retirement account within 60 calendar days. To make up for the withheld amount, additional funds from other sources must be used to ensure the entire original distribution is rolled over. Failure to meet the 60-day deadline or to deposit the full amount will result in the unrolled portion being treated as a taxable withdrawal, potentially incurring income tax and an early withdrawal penalty.

For those electing to cash out their 401(k), request a lump-sum distribution from the former plan administrator. This typically requires completing specific distribution forms. The administrator will then process the request and issue a check or electronic transfer for the distributed amount, after applicable taxes and penalties have been withheld.

If the decision is to leave the funds in the old plan, confirm with the former plan administrator that this option is permitted. Many plans allow balances above $7,000 to remain. If the balance is below this threshold, the employer may automatically roll the funds into an IRA or issue a check. It is advisable to maintain updated contact information with the plan administrator to receive statements and important communications regarding the account.