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

When employment ends, deciding what to do with your former employer’s 401(k) retirement savings plan is a key financial consideration. Several choices exist, each with distinct financial and administrative implications. Understanding these options helps you make informed decisions for your long-term financial goals and retirement planning.

Keeping Your 401(k) with Your Previous Employer

You can leave your accumulated funds within your former employer’s 401(k) plan. Your retirement savings continue to be held and managed by the previous plan administrator, allowing investments to potentially grow on a tax-deferred basis and maintain tax advantages.

Many plans require a minimum account balance, typically $5,000 or more. If your balance falls below this, the plan administrator might automatically roll over your funds into an IRA or cash them out. While leaving funds in place offers continuity, it may come with limitations such as a restricted selection of investment options and the inability to make new contributions. Administrative fees may also continue to apply. A notable benefit is that your 401(k) often retains creditor protection under the Employee Retirement Income Security Act (ERISA).

Transferring Your 401(k) to an Individual Retirement Account (IRA)

Transferring your 401(k) into an Individual Retirement Account (IRA) offers greater control and a wider array of investment choices. An IRA is a personal retirement account where you manage investments directly. This process, known as a rollover, allows your retirement savings to continue growing tax-deferred.

There are two primary methods for rolling over funds: a direct rollover and an indirect rollover. A direct rollover, or trustee-to-trustee transfer, is generally the preferred method. Funds move directly from your former 401(k) administrator to your new IRA custodian, ensuring the transfer is not considered a taxable event.

Conversely, an indirect rollover involves you receiving a check for your 401(k) balance, which you must then deposit into an IRA within 60 days. This method carries risks, including a mandatory 20% federal tax withholding. To complete the full rollover and avoid penalties, you must deposit the full original amount, making up the 20% from other funds. If the 60-day deadline is missed, the entire amount could become fully taxable and subject to early withdrawal penalties.

A pre-tax 401(k) is typically rolled into a Traditional IRA, maintaining its tax-deferred status. You also have the option to convert funds to a Roth IRA. This conversion is a taxable event in the year it occurs, meaning the amount converted will be added to your taxable income. While the conversion is taxable, future qualified withdrawals from the Roth IRA in retirement are tax-free.

Before initiating a rollover, gather necessary information from your former 401(k) plan, such as your account balance and distribution forms. You will also need to choose an IRA custodian, like a bank or brokerage firm, and prepare identification for opening the new IRA.

After selecting an IRA custodian and opening your new IRA account, contact your former 401(k) plan administrator to initiate the direct rollover process. Both the 401(k) plan and the IRA custodian will provide necessary forms. Complete and submit these forms to facilitate the direct transfer of funds between the two financial institutions, avoiding tax implications or withholding.

Moving Your 401(k) to a New Employer’s Plan

Moving your 401(k) into a new employer’s retirement plan is another viable option for consolidating your savings. This approach allows you to keep all your retirement assets in one place, simplifying financial management. The funds continue to grow on a tax-deferred basis within the new plan.

This option is contingent on your new employer’s plan accepting incoming rollovers, as not all plans do. Confirm this with your new plan administrator. If accepted, transferring your 401(k) can provide access to new investment options and fee structures within the new plan. You might also gain access to features like plan loans, if offered by the new plan, which may not be available once you leave a former employer’s plan.

To begin this process, confirm with your new employer’s plan administrator whether their plan accepts rollovers. Then, contact both your former 401(k) plan administrator and your new employer’s plan administrator. They will provide the required distribution forms from your old plan and the necessary rollover acceptance forms for the new plan. After completing and submitting these forms, coordinate the direct transfer of funds between the two plan administrators, ensuring a seamless and tax-free movement of your retirement savings.

Cashing Out Your 401(k)

Cashing out your 401(k) means taking a lump-sum distribution of your retirement funds directly. While this provides immediate access to money, it comes with significant financial consequences. The entire distribution is subject to ordinary income tax in the year it is received.

If you are under age 59½, an additional 10% early withdrawal penalty typically applies to the distributed amount, in addition to income tax. Federal income tax of 20% is usually withheld, but this may not cover your full tax liability and penalty, potentially leading to a larger tax bill. Cashing out depletes your retirement savings, forfeiting years of potential tax-deferred growth and compounding returns that are important for long-term financial security.

Limited exceptions exist for the 10% early withdrawal penalty, though the distribution remains subject to income tax. These exceptions include separation from service at or after age 55 (for 401(k)s, not IRAs), qualified medical expenses, distributions due to disability, or substantially equal periodic payments (SEPP). Other exceptions may apply for qualified reservist distributions or qualified domestic relations orders (QDROs).

If you choose to cash out, contact your former 401(k) plan administrator to request a lump-sum distribution. Complete the required distribution forms, indicating your preferences for tax withholding. Once processed, you will receive the funds, typically via check or direct deposit.