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

When an individual leaves their employment, a common question arises regarding the disposition of their 401(k) retirement savings plan. This account, designed to accumulate funds for retirement with tax advantages, requires careful consideration. The decision made about these funds can significantly impact their growth potential and accessibility. Understanding the available choices and their implications is important for preserving and maximizing accumulated retirement savings.

Leaving Your Funds in the Former Employer’s Plan

One option for your 401(k) upon leaving a company is to leave the funds within your former employer’s plan. This choice often depends on the account balance and the specific rules of the plan. Many plans permit former employees to keep their funds in the account, especially if the balance exceeds a certain threshold, such as $5,000 or $7,000. However, if the vested balance falls below a specific amount, often $1,000, your former employer might automatically cash out the account or roll it into an Individual Retirement Account (IRA).

If you choose to leave your funds in the old plan, you will no longer be able to make new contributions to the account. The investment options available will remain those offered by the former employer’s plan, which may be more limited compared to other retirement vehicles. You may also incur administrative fees, which can vary but typically cover recordkeeping and other services, potentially ranging from $45 annually per participant and up.

To determine if this is a suitable option, contact your former employer’s plan administrator. Inquire about their specific rules for continued participation by former employees, any associated fee schedules, and the available investment choices. This information will help you assess whether the plan’s offerings align with your financial goals and if the fees are reasonable. Often, no explicit action is required to leave the funds in the plan if the balance meets the minimum, but confirming this with the administrator is advisable.

Transferring Your Funds to a New Retirement Account

Transferring your 401(k) funds to a new retirement account, known as a rollover, allows your savings to continue growing tax-deferred without immediate taxation. This process has two primary methods: a direct rollover or an indirect rollover.

A direct rollover transfers funds directly from the old plan administrator to the new account custodian, ensuring no taxes are withheld. An indirect rollover means funds are distributed directly to you, and you must deposit them into a new qualified account within 60 days to avoid taxes and penalties.

For indirect rollovers, the plan must withhold 20% for federal income tax. To complete the rollover and avoid a taxable event, you must deposit the full amount, including the 20% withheld, within 60 days. This often requires using other funds to cover the withheld portion. Missing the 60-day deadline makes the distribution taxable income and may incur an additional 10% early withdrawal penalty if you are under age 59½.

Transferring to a New Employer’s 401(k)

Rolling over your previous 401(k) into your new employer’s 401(k) plan can consolidate your retirement savings. This option is available if your new employer’s plan accepts rollovers, which is common. Consolidating accounts simplifies management and tracking.

Benefits include continued creditor protection under federal law and potential loan options from the new plan. Compare the investment options, fee structures, and administrative costs of the new plan with your old one to ensure alignment with your financial strategy. Contact the new plan administrator to confirm rollover procedures and eligibility requirements.

Transferring to an Individual Retirement Account (IRA)

Rolling over your 401(k) into an IRA, either a Traditional IRA or a Roth IRA, offers increased flexibility and control over your retirement investments. A Traditional IRA rollover allows funds to continue growing tax-deferred, similar to a 401(k), and often provides a broader range of investment choices, including stocks, bonds, mutual funds, and ETFs, than typically found in employer-sponsored plans.

Converting your 401(k) to a Roth IRA involves rolling over pre-tax funds into an account where qualified withdrawals in retirement are tax-free. The converted amount is taxable income in the year of conversion. This choice can be advantageous if you anticipate being in a higher tax bracket in retirement. IRAs generally offer lower fees and more control over your portfolio.

For any rollover, a direct rollover is the most straightforward method. Contact your former 401(k) plan administrator to instruct them to transfer funds directly to your chosen new plan or IRA custodian. The new institution will provide necessary forms and instructions.

Taking a Direct Distribution from Your 401(k)

Taking a direct distribution, or cashing out, from your 401(k) means receiving your retirement funds as a lump sum. This option has immediate and substantial tax implications. Distributions from a traditional 401(k) are generally subject to ordinary income tax, meaning the entire amount distributed (unless previously taxed contributions) is added to your taxable income.

If you are under age 59½, an additional 10% early withdrawal penalty typically applies to the taxable portion. Exceptions to this penalty exist, though income tax still applies. These exceptions include distributions due to:

• Total and permanent disability
• Certain unreimbursed medical expenses
• Separation from service at age 55 or older (age 50 for public safety employees)
• Substantially equal periodic payments (SEPP)
• Emergency personal expenses up to $1,000 per year
• Victims of domestic abuse

A mandatory 20% federal tax withholding applies to eligible distributions, even if you intend to roll over the funds. The plan administrator sends this 20% directly to the IRS. This withholding may not cover your full tax liability, and you may owe more when filing your tax return.

Cashing out your 401(k) means losing the benefit of tax-deferred growth. Funds removed will no longer grow tax-free, potentially diminishing your overall retirement nest egg. It is generally advised to avoid this option unless absolutely necessary due to significant tax consequences and loss of future growth.

To request a direct distribution, contact your former 401(k) plan administrator for necessary forms. They will issue a check or electronic transfer for the distributed amount, minus the mandatory 20% federal withholding and any applicable state withholdings. You will receive IRS Form 1099-R by January 31 of the year following the distribution, detailing the gross distribution, taxable amount, and taxes withheld for filing your income taxes.