Q: Our employer has what seems like a fairly good 401(k) plan - they match the first 4 percent of salary that goes into the plan. However, I'm concerned about how much to put into it because you can't participate in the plan after you leave the company.
Does that mean I lose what I put into it or have to pay a tax penalty for taking money out before I reach retirement age?
A: From your question, it seems you have not yet decided to leave your employer but want to look before you leap.
The answer applies both to your current plan balance as well as to your future 401(k) contributions -- so it might be helpful to break it down into two parts:
- What to think about before deciding to leave your employer
- How to minimize the consequences if you do leave
401(k) plans - what to do before leaving your employer
It's worthwhile to consider the 401(k) employer match before changing jobs. In particular, if you participate in your 401(k) plan enough to take ample advantage of the employer match, you should factor the value of that match into any comparison of salary and benefits at a potential new employer.
Sizing up the employer match
If your employer fully matches the first 4 percent of your salary that goes into the plan, that is a pretty generous match because most often employers with a match will contribute just 50 cents on each dollar you put in. However, there are employers with more generous plans:
- Some employers contribute money on your behalf whether or not you put in any of your salary. According to data from Vanguard, 41 percent of employers make this kind of non-matching contribution.
- If your employer's match is capped at 4 percent of your wages, that is a little below what most workers are able to get out of their plans. However, if you do not contribute heavily to your plan, you probably would not get those extra matching dollars anyway.
There are other things to consider when comparing 401(k) plans such as fees and menu design. However, the employer match is the one likely to make the most significant impact on your wealth. Also, as discussed below, what happens to the employer match is a consequence you should be prepared for when changing jobs.
Minimizing 401(k) plan consequences if you change jobs
Let's say you've compared salary, benefits and other factors and have decided to change jobs. How can you minimize the consequences to your existing 401(k) balance?
There are two types of consequences here: tax consequences and how much of your current 401(k) balance you are eligible to take with you.
How to avoid potential 401(k) plan tax consequences after you leave
If you leave an employer's 401(k) plan, any distribution to you that is not rolled over into another qualified retirement plan will be subject to ordinary income taxes. In addition, if you are younger than age 59 1/2, it will be subject to a 10 percent tax penalty.
You can avoid those tax consequences if you roll your 401(k) balance into a qualified retirement plan within 60 days. This could be a 401(k) plan at your new employer or an IRA rollover you set up on your own behalf.
It is advisable to set your rollover plans in motion as soon as you leave your employer to make sure you do not miss the 60-day deadline.
What part of your 401(k) balance might you leave behind?
The core motivation behind your question seems to be whether you should be cautious about contributing to your 401(k) in case you might have to leave some of that money behind when you leave your employer. Besides taxes, this is another potential consequence of changing jobs -- but it should be manageable.
First and foremost, rest assured that the entire portion of your balance attributable to your contributions is yours to take with you when you leave your employer. Thus, the only way you can take out of a 401(k) plan less than you put into it is if your investments are down when you leave the plan.
That leaves the portion of your balance that is attributable to employer contributions on your behalf, which may be subject to some sort of vesting schedule determining when you become eligible to take that money with you. According to Vanguard, just over half of 401(k) plans have some form of vesting requirement for employer contributions. This means you have to stay with the company for a specified period of time in order to keep that money.
A vesting requirement may be triggered in stages or all at once, and may take several years. It is wise to know a plan's vesting requirement from when you first start making contributions to the plan. Depending on your career intentions, this may be a factor in how much you count on employer contributions, and it will save you from arousing suspicion by inquiring about the vesting requirement when you are thinking of leaving the company.
Overall, 401(k) participation is a good deal no matter what your intentions about staying with your current employer; but it is smart to know about tax consequences and vesting requirements so you can anticipate the impact of any job changes on your plans for retirement.
One final note: if you have borrowed money from your 401(k) balance that you have not yet repaid, you are almost certain to be required to repay this loan immediately when you leave the company. If you don't, it will be considered a distribution from the plan and will be subject to the tax consequences described above.
More resources on 401(k) plans
Need more information? Read our comprehensive guide on Leaving My Employer: What to do with 401(k) money
For basic information on 401(k), read 401(k) Retirement Savings Plan Basics