What Happens to Your 401k When You Leave a Job?
Being fully-vested in a company doesn’t mean you wear a three-piece suit to work. It has to do with how long you have been employed and how much of your 401k you’ll be able to take with you when you leave.
Speaking of leaving — nobody likes to quit, and fewer people like to get fired. It happens, though, and so you need to know what to do with your 401k when you leave a job.
401k Plans
A 401k plan is a retirement savings plan offered to employees through their company that has tax advantages to the saver. The employee chooses to contribute a certain amount of their paycheck to the account, and the employer can match a portion or all the contribution.
There are two types of 401k plans – traditional and Roth – which differ in how they are taxed. Traditional IRAs are “pre-tax,” meaning taxable income is reduced, but withdrawals are taxed. Contributions to a Roth 401k are made with income that has already been taxed. There is no deduction on taxes during the year, but withdrawals are tax-free.
How Your 401k Vested Balance Works When You Are Fired or Quit
Since your 401k is linked to your employer, you won’t be able to contribute to it anymore when you quit your job. If you want to keep adding to it, you can move it out of your old company’s account and into a new retirement savings plan.
Another option is to do nothing. According to Ellevest, if your account provides you with access to investment plans with low fees or unique investment options, it might be a better idea to stay with your current plan. Read more about your options below.
What Can You Do with Your 401K Money After Employment Ends?
Leave the Money in Your Former Employer’s Program
If you have moved on to a new job and have more than $5,000 invested in your 401k, most plans will allow you to leave the money with your employer. If your tax contributions are under $1,000, the company can issue you a check, relieving you of the 401k. If it is between $1,000 to $5,000, the company can help you create a new IRA if they are forcing you out.
If you have a good amount of money saved up and you don’t want to change your current plan portfolio, you can leave your 401k with your previous employer. If you do not care for the account or do not like the plan’s investment fees or options, you may need to investigate other investment options.
Roll It Over into Your New Employer’s Plan
Once you have changed your job, see if your new employer offers a retirement plan and see when you are eligible to join it. Many employers require employees to work for the company for a certain amount of time before qualifying for a retirement savings plan.
When you enroll in a plan with your new employer, it is easy to roll over your old 401k. You can have the administrator of the old plan deposit the contents of your account into the new plan by filling out a bit of paperwork. This is called a direct transfer and is made from custodian to custodian, and it prevents you from paying any taxes or missing a deadline.
You can also have the balance of your old account converted into a check. However, you will need to transfer the funds to your new retirement savings account within 60 days, so you don’t have to pay income tax on the total amount. Be sure to check and see if your new 401k is active and ready to receive the contributions.
Money in the 401k of your current employer is not subject to required minimum contributions.
Take Distributions
You can start taking distributions from any 401k after the age of 59-and-a-half. This means you can take out money without paying the 10% tax penalty for early withdrawal. If you are retiring, it might be a good time to start using your savings account for income. With a traditional 401(k), you need to pay income tax at your ordinary rate on any distributions that you take. If you have a Roth account, any distributions you take after age 59-and-a-half are free of taxes as long as you have had the account for a minimum of five years. If you do not meet this requirement, only the earnings portion of your distributions will be taxed.
If you retire before age 55 or change your job before 59-and-a-half, you might still need to take distributions from your 401k. However, you will need to pay a 10% penalty, as well as income tax, on the taxable portion of your distribution, which might be all of it. The 10% penalty on taxes will not apply to those who retire after 55 but before age 59-and-a-half.
When you reach the age of 72, you are expected to take required minimum distributions (RMDs) from your retirement savings plan when you leave your job.
Take the Money
You can also just take the money and leave. It is possible to liquidate an old 401k and take a lump-sum distribution, but most financial advisors strongly advise against it. You will have to face a 10% early withdrawal penalty if you choose to take this route. It reduces your retirement savings significantly, and you will be taxed on the entire amount.
Rolling Over Your Old 401k When You Find a New Job
If you decide to roll over your 401k, contact the administrator at your new company for a new account address. You will provide the address to your old employer, and the money will be transferred directly from your old plan to the new one. Or the money can be sent by check to you, which you will give to your company’s new 401k administrator.
This is called a direct rollover. It is a simple process and transfers the entire balance without any taxes or penalties. Another similar process is the direct trustee-to-trustee transfer. Much of the process is completed online between administrators of the retirement plan, which requires little action on your part.
What Are Some Rollover Exceptions?
The following is a list of cases where the 401k may not be eligible for rollover:
- Required minimum distributions (RMDs)
- Hardship distributions
- Distributions of extra contributions and similar earnings
- Distribution that is one of several period payments
- Distribution used to pay for accident, health, or life insurance
Other limitations include trying to roll over dividends on employer securities or withdrawals electing out of automatic contribution arrangements.
Conclusion
There are several options available to you if you are leaving your job and do not know how to handle your 401k plan. Just be sure to thoroughly research your choices before you decide what works best for you. The goal is to avoid paying fees or pay lower fees, penalties, or unnecessary taxes.
You may be interested in these blogs, too:
