Here's What Happens To Your 401(k) When You Leave Your Job

You're pumped for your new gig, but aren't you forgetting something?
No, it really isn't an opportunity to mismanage your savings.
SIphotography via Getty Images
No, it really isn't an opportunity to mismanage your savings.

Let’s face it: Nowadays, most workers don’t stay in the same job or work for the same company for the duration of their careers. But what happens if you funded a 401(k) and then switch jobs, leave your company or get laid off? What happens to the money you accumulated when you move on?

The important thing to know is you get to decide what happens to it. Here are some of your options, assuming you are too young to begin taking distributions:

Do Nothing

Yes, you can do absolutely nothing ― which means your 401(k) will stay with the employer you are leaving and that company will continue to manage it. You will receive regular statements on how your money is doing. Your former employer will no longer be offering any match for contributions, of course, which makes sense since you won’t be making any more contributions to this account anyway.

Doing nothing is a perfectly sensible option. For one, if you are happy with your funds’ performance, your fund choices and the fees that you are charged, it means you won’t have to upset the apple cart just because you want to switch jobs.

But one thing you will want to check is whether the company you are leaving is OK with you leaving your money behind. You do that by asking. It’s also an excellent opportunity to inquire how much your fees are and will be for leaving your money behind.

Most plans will let you leave your 401(k) where it is ― but not all of them. In some cases, they won’t allow it if you have only a small amount saved, generally $1,000 or less. Should the company not want to continue managing your fund, you will have 60 days after you leave to figure out where to put your money. If you miss that deadline, your 401(k) money may wind up being sent directly to you, an act that could leave you exposed to early withdrawal penalties and taxes.

The best advice we can offer about doing nothing is this: If you are going to do nothing, do it as a proactive choice, not as a default born from inaction. In other words, understand what all your options are. And if you pick leaving it with your former company, do so because it is your best choice and not just because you forgot about it.

Roll It Over

If you are leaving for another job, you may roll over an old 401(k) into a new 401(k) account with your new company. This means you will be merging your old savings and having it plus your new savings managed by your new employer. That’s perfectly fine, but not without a few land mines to avoid.

If you’ve switched jobs, find out whether your new employer offers a 401(k) and when you are eligible to participate in it. Frequently, new employees are required to work for a certain number of months before they become eligible to enroll in a company’s retirement savings plan. Find out when you can enroll first because you can’t roll over your old 401(k) until you are enrolled in a new plan.

Then it’s pretty easy. You can direct the administrator of the old plan to move the contents of your account directly into your new plan. It’s just some paperwork ― but you don’t want to get stuck “holding the bag,” so to speak.

And that’s what will happen if you don’t have a new account ready to receive it: The balance of your old account will be distributed to you in the form of a check if you haven’t directed it to be rolled over into your new 401(k). Should you wind up with a check made out to you with the balance of your former 401(k), you must deposit the money into your new 401(k) within 60 days to avoid paying income tax on the distribution. So, make sure your new 401(k) account is active and ready to receive contributions before you liquidate your old account.

Open An IRA

If you are switching jobs to work for a company that doesn’t offer a retirement plan that you can roll funds into, you can consider opening an individual retirement account to move your 401(k) funds into and continue your retirement savings. (You can actually open an IRA any time, and there really isn’t any downside to having both a 401(k) and an IRA.)

The two platforms are similar. A 401(k) is what companies offer to workers, and companies often offer to match a certain level of contributions for each employee. A traditional IRA has no such match, but does give the saver more freedom to manage his or her own money. A Roth IRA is a third type of retirement savings plan. It offers the same ability to manage your own money as the traditional IRA, plus has no required minimum distributions in retirement.

Both traditional IRAs and Roth IRAs have caps on how much you can contribute annually ― and those ceilings may get in the way of you saving adequately for retirement.

There basically isn’t a wrong answer here. If you do have the option of a 401(k) at work with an employer match, generally you want to take advantage of that and fund it first. Why walk away from “free” money when it’s offered?

Take The Money And Run

While there is nothing legally stopping you from liquidating your old 401(k) and taking a lump-sum distribution, you probably shouldn’t. Why were you saving in the first place if you intended to deplete your retirement savings unnecessarily just because you could? You will have to include the distribution in your yearly income tax filing, and the tax burden of a full withdrawal may not be worth what feels like a windfall at the moment.

How big a hit will you take? You will be taxed at your regular income tax rate and pay a penalty of 10 percent of the amount of the distribution if you take it before you are 59.5 years old. You can calculate just how much it will cost you with this calculator.

Plus, you will have to start saving for retirement all over again.

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