Whether you’ve been laid off or chose to leave your employer, facing a major life transition can be both stressful and exciting. As you celebrate a new chapter, don’t forget about an important financial consideration – your retirement savings in your former employer’s 401k plan.
In this blog post, we’ll walk through all of your options for what to do with your 401k after leaving a job and help you make the best decision for your unique financial situation and goals.
Your 401k plan is intended to help you save for retirement, so keeping those funds growing tax-deferred should remain a priority even after switching jobs. Let’s jump right in and explore the key things you need to know.
Leave it Where It Is (If Your Balance Is Over $5,000)
One simple option is to leave your 401k savings right where they are in your former employer’s plan, if the balance is over around $5,000. Most 401k plans allow former employees to keep balances in the plan indefinitely, even after separating from the company.
Leaving it alone avoids any hassle or fees associated with moving the money. You also maintain investment options and control through the original plan. Just be sure to review and adjust your investments periodically to match your time horizon and risk tolerance as retirement nears.
Some potential downsides include fewer investment options compared to an IRA. You also lose the ability to make further contributions once you leave that job. Employer matching contributions will obviously cease as well.
So in summary, leaving a 401k untouched can be a hands-off approach if your balance is healthy. But you may want more control or options down the road – which brings us to our next choice.
Roll It Over to an IRA
The most common next step is rolling over your 401k savings to an Individual Retirement Account, commonly referred to as an IRA. This lets you consolidate multiple employer-sponsored retirement accounts under one IRA “umbrella” for easier management over time.
Rolling over to an IRA has several advantages:
- More investment choices – IRAs typically offer far more fund options from different providers to suit your needs. This can mean lower costs too.
- Control and portability – An IRA moves with you as you change jobs. You also control contributions, withdrawals, and beneficiary designations directly.
- Potentially lower fees – 401k administrative fees may be higher than low-cost IRA providers. Rollovers avoid these ongoing charges.
- Ability to make future contributions – With an IRA, you can continue contributing up to the annual IRS limits even without an employer plan. Great for saving more.
To complete a rollover, contact your 401k provider and request distribution to your new IRA. You have 60 days to deposit the funds into an IRA to avoid tax penalties. Be aware of any surrender charges for cashing out early from the 401k.
So in most cases, an IRA rollover is an excellent move. It frees your savings from a former job and gives you more control in one central retirement account.
Cash Out Your 401k (Not Usually Recommended)
For some, the immediate cash in hand from a 401k cash-out may seem tempting. However, there are steep penalties for withdrawing 401k funds before age 59.5 that make this a poor choice in nearly all situations.
Specifically, cashing out a 401k early results in:
- Up to a 25% mandatory federal tax withholding on the amount cashed out
- An additional 10% early withdrawal penalty if under age 59.5 (unless an exception applies)
- Income taxes owed on the entire withdrawal amount in the year cash is received
So in reality, cashing out a 401k to access funds early often means receiving only around 55-60 cents on every pre-tax dollar withdrawn. The lost growth potential of keeping retirement savings invested for decades also cannot be overlooked.
While very rare exceptions apply for things like medical expenses over 10% of AGI, in almost every case it is better to avoid cashing out a 401k if possible through a rollover to an IRA or leaving the funds where they are. Spending retirement savings should always be an absolute last resort.
Leave It with a New Employer’s 401k
If starting a new job that offers a 401k, consider asking your new employer if they support rolling your balance from your previous 401k into the new plan. Many firms allow “incoming rollovers” from other 401k or IRA accounts these days.
Bringing old 401k money into a current employer’s new 401k can be convenient – one less account for you to track over time. Your savings all remain in the pre-tax 401k wrapper with the same tax advantages too.
However, make sure to evaluate your new plan’s investment options carefully. A new 401k may have limited funds compared to an IRA. You also lose the ability to manage those balances independently down the line if leaving that new employer.
Proceed with combining 401k accounts only if satisfied the new plan makes sense long-term. Otherwise, an IRA rollover may provide more flexibility into retirement.
Consider a Hybrid Approach
Depending on your specific needs and situation, a hybrid approach using elements from multiple options could work well too. Here are some ideas:
- Roll most of your 401k to an IRA but leave a small balance in the employer plan if needed for ongoing access before retirement.
- Consolidate multiple employer 401ks into one Rollover IRA, then roll a portion into a new employer’s 401k if better options exist.
- Roll your 401k to a Rollover IRA, then combine IRA into your spouse’s current employer’s 401k if eligible for better investment or creditor protection benefits.
Thoughtfully weighing the pros and cons of mixing 401k strategies based on your goals allows customizing a solution. Just be sure any complex arrangements are coordinated properly to avoid tax implications.
Watch Out for 401k Loan Repayments
If you left a previous job with an outstanding 401k loan, be aware of strict repayment rules. Any unpaid balance becomes a taxable distribution if not settled promptly upon ending employment.
For example, if you resigned with $5,000 left on a 401k loan but didn’t repay it, the entire $5,000 becomes subject to ordinary income taxes plus the 10% early withdrawal penalty if under age 59.5.
To prevent this scenario, carefully review loan terms for deadlines to pay off the balance in full or potentially face dire tax consequences. Rolling your 401k balance to an IRA may also initiate a deemed loan repayment owed. Properly close out any loans prior to altering your retirement accounts.
Consider Your unique Situation
When choosing what to do with your old 401k, think through less obvious factors relevant to your specific financial life stage and priorities:
- Income needs in retirement – Roth conversions may make sense if expecting lower future tax rates in retirement.
- Credit protection – 401ks have unlimited protection from creditors, while IRAs only offer $1M protection.
- Required Minimum Distributions – RMDs apply earlier for 401ks – age 72 vs. April 1 after age 72 for IRAs.
- Inheritance plans – Consult beneficiaries for their needs and goals when inheriting retirement funds.
- Current/future employment status – Self-employed? Contract work? May prefer ongoing IRA contributions over 401k options.
With patience and diligence reviewing your personal circumstances, the right 401k decision ideally supports both your retirement savings trajectory and life priorities holistically now and down the road. Commit to the action steps that best accommodate your unique situation.
Take Advantage of Deadlines
Always be aware of deadlines for actions like rollovers. Attempting distributions or transfers outside allowed windows can trigger unintended taxes and penalties.
Additionally, the CARES Act offered expanded distribution and loan flexibility in 2020-21 due to the coronavirus pandemic. Be sure any utilization follows applicable guidelines.
Key 401k deadlines to note:
- 60 days for IRA rollovers without tax consequences
- Dec. 31 each year to make annual IRA contributions
- April taxes to finalize any backdoor Roth conversions from prior year
Proactively managing paperwork and timing for 401k moves ensures you fulfill requirements properly and optimally leverage available strategies when applicable or advantageous.
With diligence and patience, you’ll set yourself up to make an informed, advantageous decision for your specific 401k funds leaving any employer. The options we covered, along with consideration of individual factors, help light the path for creating a customized approach aligned with your long-term retirement goals.