What to Do With Your 401k When You Leave a Job
Learn how to manage your 401k effectively after leaving a job. Understand your choices for smart financial planning.
When transitioning between jobs, your 401(k) retirement savings require careful consideration. Informed decisions about these funds are important for your long-term financial well-being. The choices you make significantly impact your retirement savings growth and accessibility. This article guides you through the options available for your 401(k) when you leave an employer.
Understanding Your Options
Upon separating from an employer, you generally have four primary options for your 401(k) plan. You can leave the funds in your former employer’s plan, if permitted. A second option involves rolling over the funds into a new employer’s 401(k) plan, if offered and accepted.
Alternatively, you might consider rolling over your 401(k) balance into an Individual Retirement Account (IRA). The fourth option is to cash out your funds, receiving a direct distribution. Each of these choices carries distinct implications for your retirement savings.
Factors in Your Decision
Several factors should guide your decision regarding your 401(k) funds when changing jobs. Understanding the tax implications of each option is important. Rolling over funds directly to another qualified retirement account, such as an IRA or a new 401(k), allows your money to continue growing on a tax-deferred basis.
However, cashing out your 401(k) typically subjects the distributed amount to ordinary income tax. If you are under age 59½, an additional 10% early withdrawal penalty may apply. Some exceptions to this penalty exist, such as separation from service at age 55 or older, or permanent disability. For Roth 401(k)s, qualified distributions are tax-free, but non-qualified distributions of earnings may be taxable and subject to penalties.
The fees and expenses associated with your retirement account also warrant careful consideration. 401(k) plan fees can vary significantly, depending on factors like the plan’s size and provider. The average total plan cost for a 401(k) participant was around 0.49% of plan assets in a recent report. These fees, which include investment management and administrative costs, can impact your long-term returns.
The range and flexibility of investment choices differ between employer-sponsored plans and IRAs. IRAs often provide a broader array of investment options and greater control over your portfolio compared to many 401(k) plans. Conversely, some employer plans may offer unique investment options or institutional-class funds not readily available in an IRA.
Rules regarding access to funds and future withdrawals are also important. Required Minimum Distributions (RMDs) generally begin at age 73 for most traditional 401(k)s and IRAs, requiring you to start withdrawing funds annually. However, if you are still employed past age 73 and do not own more than 5% of the business, you may be able to delay RMDs from your current employer’s 401(k) until retirement. Early withdrawals before age 59½ typically incur a 10% penalty in addition to income taxes, with some exceptions.
Creditor protection is another factor to evaluate. Funds held in 401(k) plans generally receive strong protection from creditors under federal law, specifically the Employee Retirement Income Security Act (ERISA). This protection typically extends to bankruptcy and other legal liabilities. IRAs, while protected in bankruptcy up to a certain federal limit, rely more on state laws for protection outside of bankruptcy proceedings. Rolling over funds from an ERISA-protected 401(k) to an IRA may alter the level of creditor protection.
Steps to Implement Your Choice
Once you have decided on the best course of action for your 401(k) funds, implementing your choice involves specific steps. For a direct rollover, the funds are transferred directly from your former employer’s plan administrator to the new account custodian, whether an IRA or your new employer’s 401(k). This method bypasses you entirely, ensuring no taxes are withheld and eliminating the risk of missing a rollover deadline. You will need to contact your former plan administrator to initiate this process, providing them with your new account details.
An indirect rollover involves the funds being distributed to you personally, usually via a check, before you redeposit them into another qualified retirement account. If you choose this option, you have 60 days from the date you receive the distribution to deposit the funds into a new retirement account to avoid a taxable withdrawal. The plan administrator is generally required to withhold 20% of the taxable amount for federal income taxes from such distributions. To complete the rollover of the entire original balance, you would need to add funds from other sources to cover the withheld amount.
If you decide to cash out your 401(k) funds, you will need to request a distribution from your former plan administrator. Cashing out will result in the immediate taxation of the distributed funds and may incur an early withdrawal penalty if you are under age 59½.
If leaving your funds in your former employer’s plan is your preferred option, it often requires minimal action. However, confirm with the plan administrator that your balance meets any minimum requirements for remaining in the plan. Some plans may automatically roll over small balances (e.g., under $5,000) into an IRA or distribute them if you do not make an affirmative choice.