Did you recently leave your job and have a 401(k) plan? Then you have some important choices in front of you! I will discuss what happens to your 401(k) retirement funds when you leave a job. But don’t worry, none of it is difficult to do. With all of its tax advantages, the money in your 401(k) is yours to keep – including all employer contributions. However, it is important to review your options before you make a decision.
Key Takeaways
- You can leave it as is.
- You can roll it over into a new 401(k).
- You can roll it over into an IRA.
- You can cash out a lump sum.
- You can start taking qualified distributions if you meet all requirements.
What Is A 401(k) Account?
Before we begin, let’s quickly refresh what a 401(k) account is. A 401(k) account is an employer-sponsored retirement account.
You contribute to your account through your paycheck. That’s done with pre-tax dollars – so before your paycheck hits your bank account, the contribution to your 401(k) is already done. This is why your 401(k) account is considered to be tax-advantaged.
Once you have a plan, you can select the type of investment to use to grow your contributions over time. There are many different options, but a target date fund is the most widely offered option. These are funds designed with your retirement age in mind. The closer you get to your retirement age, the more conservative your money will get invested. The other extreme on the spectrum is a self-directed brokerage account. With such an option, you can freely choose what you want to invest. It functions the same as a normal brokerage account and allows you to invest in ETFs, mutual funds, or individual stocks.
Some employers offer additional benefits like a 401(k) employer match – essentially free money for you as an incentive to make contributions to your plan.
Leave It As Is
When leaving a job that offers a 401(k) plan to you, your simplest option is to just leave it as is. The plan will continue like before, just without any additional contributions from you or your old employer. You can leave your money in the plan and keep it invested exactly like before.
One possible downside could be that this can make it harder for you to track your retirement savings. Over time, you could potentially end up with many different accounts.
Another downside to consider is fees. Some 401(k) providers might charge you fees if you no longer work at the company that sponsored the plan. You generally want to have your money in an account with lower fees and great investment options.
But there are also reasons to keep your money in your 401(k). One possible reason could be that your new 401(k) isn’t offering the type of investments that you have in your old account. Not all 401(k) plans offer the same investment vehicles.
Roll Over Into New 401(k)
When switching jobs between employers offering 401(k) plans, you can study their offerings and decide to roll over your previous 401(k) plan into your new employer’s plan.
Having only a few or perhaps only a single 401(k) account can be a good idea and greatly simplify your retirement situation. There are fewer accounts to track.
Besides the simplicity of your retirement plan, another reason to do a rollover is if the new plan offers more flexibility to you. Maybe your new plan offers better investment choices to grow your money more effectively.
Talk to your plan administrators to initiate the rollover process into your new account.
Roll Over Into IRA
You can also roll over your 401(k) into a traditional IRA (individual retirement account) account. It works the same as rolling over into another 401(k).
An exception would be if your new IRA account is a Roth IRA. In that scenario, you will have to pay income taxes on the transferred money. That’s because Roth IRAs have a different tax advantage than a traditional 401(k).
If your 401(k) account is a Roth 401(k), rolling over into a Roth IRA will not trigger any income tax liability.
Direct Vs. Indirect Rollover
A direct rollover from one 401(k) account into another 401(k) or an IRA account must be done carefully. Your providers will help you with that direct transfer. The most important part is to follow the procedure carefully to avoid unnecessary tax liability. Talk to your plan administrators to initiate your rollover. Normally, your previous plan administrator would send you a check payable to your new 401(k) plan.
You will have 60 days to complete the transaction. The money itself never lands in your own bank account but gets transferred between your accounts directly. This is how you avoid paying any taxes on the money you roll over. If you were to miss the deadline, you would likely have to pay an early withdrawal penalty alongside the income tax on your gain that you now realize. You absolutely want to avoid such a situation.
With an indirect rollover, you would get sent a check for your 401(k) money, excluding taxes. You now have 60 days to deposit the check alongside the withheld taxes. You will have to come up with the taxes that are withheld on your own. Come tax season, you can get a refund for those taxes.
Cash Out: Take A Lump Sum – Rarely A Good Option
Technically, you can withdraw your invested money from your 401(k) account at any time with a lump-sum distribution. However, there are some rules to follow to avoid having to pay early withdrawal penalties and taxes.
Any withdrawal before you are 59 1/2 years old will trigger an early withdrawal penalty. That penalty tax is currently 10%, and it is in addition to the income tax that you will have to pay on any withdrawal.
Maybe you urgently need the money now and see this as a reason to cash out your 401(k)? If that’s the case, you could also explore a hardship withdrawal. Some plans may allow a hardship withdrawal for you, your spouse, or your dependent for certain medical expenses or tuition and other related educational expenses. Check if you would qualify for any of the exceptions to the 10% penalty tax. It’s important to look closely at your plan to determine if your reason for withdrawal meets the criteria for a hardship withdrawal.
Special Rules For Low-Balance 401(k) Accounts
If your 401(k) account carries a balance below $5,000, some special rules exist that can impact your options.
Below a balance of $1,000, your plan administrator can withdraw all the money and send you a check for it, excluding the taxes.
If your balance is below $5,000, your employer can move your money into an IRA account. He can open a new account in your name if you don’t have one.
In both cases, you can still initiate a rollover. But time is of the essence since neither of these special rules requires your consent.
Qualified 401(k) Distributions
I generally recommend you only take distributions from your 401(k) money if they are qualified distributions, if possible. Only qualified distributions will prevent you from having to pay the 10% penalty tax on your withdrawal.
In order for a distribution to be qualified, you have to be 59 1/2 years old. Any withdrawal you make before reaching that age will not be treated as a qualified distribution. A rollover from one qualified 401(k) account into another qualified account is also considered a qualified distribution. That’s why you will not have to pay any penalty on your rollover.
If you take a qualified distribution from your 401(k) plan, you will have to pay income taxes on the distribution.
Final Thoughts – What Happens To Your 401(k) When You Leave A Job?
When it comes to retirement, having a plan is the way to go. We will all most likely change jobs a number of times during our careers. If you enjoy the benefit of 401(k) accounts through your employer, you need to know the options available when leaving a job or starting a new job. Knowing the rules can help you save a lot of money and prevent unnecessary mistakes.
It also does not matter if you leave your job or you get fired from your old job. Former employees are subject to the same rules regardless of how they ended their employment.
Disclaimer: The information in this blog post should not be considered investment advice or a replacement thereof. They are solely provided for informational purposes. Please consult with a financial advisor for any specific questions on your financial situation. Remember that past performance is not a good indicator of future returns. Also, none of the mentioned stocks are to be understood as recommendations. Don’t buy yourself something solely based on what you read here.
Disclaimer: The information in this blog post should not be considered tax advice or a replacement. They are solely provided for informational purposes. Please consult with a tax professional or tax advisor for any specific questions on your taxes. Also, none of the mentioned stocks are to be understood as recommendations. Don’t buy yourself something solely based on what you read here.
You should talk to a financial advisor and tax professional if your tax situation becomes more complex. Finding a good financial advisor is not easy. I recommend the Garrett Planning Network, the National Association of Personal Financial Advisors (NAPFA), and the XY Planning Network. These networks can get you in contact with a fee-only advisor. No matter how much money we are talking about, it will not change your costs.
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