What to Do With Your 401(k) After Quitting a Job

A 401(k) plan is an employer-sponsored retirement savings vehicle, allowing individuals to contribute a portion of their paycheck for future financial security. These plans typically offer tax advantages, such as pre-tax contributions or tax-free growth, depending on whether it’s a traditional or Roth 401(k). For many, a 401(k) represents a significant component of their long-term financial planning.

Leaving a job presents a common scenario where individuals must decide the fate of their accumulated 401(k) savings. This transition requires careful consideration, as choices made can significantly impact the growth and accessibility of retirement funds. Understanding the available options and their implications is important for maintaining financial momentum.

Maintaining Your Account with a Former Employer

One option upon leaving a job is to leave your 401(k) account with your former employer. This is typically available if your vested balance exceeds $5,000. If your balance is below this amount, your former employer might automatically roll the funds into an IRA or even issue a cash distribution, especially if the balance is under $1,000.

Leaving funds in the old plan can offer advantages, such as familiarity with existing investment options and potentially lower fees. 401(k) plans generally provide strong creditor protection under the Employee Retirement Income Security Act (ERISA). However, this approach can lead to limited investment choices, and there’s a risk of losing track of the account.

If you choose this path, ensure you update your contact information with the plan administrator. Regularly review the account’s performance and confirm that the investment strategy remains suitable. While you cannot make new contributions, managing your existing investments within the plan is usually possible.

Transferring to a New Employer’s 401(k)

Moving your previous 401(k) balance into a new employer’s 401(k) plan offers the benefit of consolidating retirement savings. Eligibility for the new plan often involves a waiting period. This option allows for continued pre-tax growth and potentially higher contribution limits, such as the $23,000 limit for elective deferrals in 2024.

Consolidation can simplify managing your retirement portfolio and maintain strong creditor protection through ERISA. Some plans also offer loan options. However, the new plan might have limited investment choices or different fee structures.

To execute this, you initiate a direct rollover, where funds move directly from your old plan administrator to your new one. This process avoids any direct receipt of funds, preventing tax implications and potential penalties. Contact both plan administrators to obtain necessary forms and coordinate the transfer.

Rolling Over to an Individual Retirement Account

Rolling over a 401(k) into an Individual Retirement Account (IRA) offers increased control and a broader range of investment choices. This option allows you to select between a Traditional IRA or a Roth IRA, each with distinct tax treatments. A Traditional IRA rollover continues the tax-deferred growth, meaning contributions and earnings are taxed upon withdrawal in retirement. Conversely, a Roth IRA rollover involves converting pre-tax 401(k) funds, making the converted amount taxable as ordinary income in the year of conversion. However, future qualified withdrawals from the Roth IRA are tax-free.

The distinction between a “direct rollover” and an “indirect rollover” is important. A direct rollover moves funds directly from your 401(k) administrator to your chosen IRA custodian, avoiding immediate tax consequences. In an indirect rollover, you receive the funds yourself, and you must deposit them into an IRA within 60 days to avoid being taxed as a distribution and potentially incurring a 10% early withdrawal penalty if you are under age 59½. Indirect rollovers often incur a mandatory 20% federal tax withholding, which you would need to cover from other sources to roll over the full amount.

Advantages of an IRA include a wider selection of investment products, offering more flexibility to tailor your portfolio. However, IRAs generally offer less creditor protection than 401(k)s, as ERISA protections do not apply to IRAs.

When preparing for an IRA rollover, research and select an IRA provider. Decide whether a Traditional or Roth IRA best suits your tax strategy, considering your current income and anticipated future tax bracket. Contact your former 401(k) administrator to request a direct rollover, providing them with the necessary instructions and account details from your IRA custodian.

Understanding Cash Distributions

Opting for a cash distribution from your 401(k) involves withdrawing the funds directly rather than transferring them to another retirement account. This choice has significant negative financial consequences. Any amount received is taxed as ordinary income, potentially placing you in a higher tax bracket.

If you are under age 59½, these withdrawals are generally subject to an additional 10% early withdrawal penalty on top of the regular income tax. Some exceptions exist, such as the Rule of 55 or withdrawals for unreimbursed medical expenses. The plan administrator is generally required to withhold 20% of the distribution for federal income taxes.

Requesting a cash distribution involves contacting your former 401(k) plan administrator and completing their required distribution forms. You will receive a check or direct deposit for the distribution amount, minus the mandatory 20% federal tax withholding. This initial withholding may not cover your full tax liability, potentially leaving you with an additional tax burden and penalty. This option is generally not recommended due to the substantial reduction in retirement savings caused by taxes and penalties.