Leaving my employer: What to do with 401(k) money?Richard Barrington
Oftentimes, changing jobs means changing your retirement plan. If you have been participating in a 401(k) plan at your present job and intend to leave, you have several options about what to do with your 401(k) balance.
It's an important decision -- especially if you've been contributing to a 401(k) plan for several years. You may already have built up a substantial balance in that plan. Thinking through about what to do with that money next can help you get the most value out of that balance.
Whether you can leave your 401(k) at an old job or not depends on both the plan and the size of your 401(k) balance. If you have less than $5,000 in the 401(k) when you leave, the plan sponsor can force you out of the plan and probably will.
If you have more than $5,000 in the 401(k) when you leave, you are legally entitled to remain in the plan. If you've been happy with the investment performance and administration of the plan, this may seem like a comfortable choice. However, bear in mind that you probably won't continue to receive the same level of communication about plan developments after you leave the company.
In addition, there are benefits to consolidating your retirement assets rather than spreading them among different plans. These benefits will be discussed later in this slideshow.
Learn more: 401(k) retirement savings plan basics
How long do you have to move your 401(k) after leaving a job?
In cases where your 401(k) balance is low enough that you can be forced out of the plan, the employer may do so with as little as 30 days' notice.
If your employer distributes a check to you rather than rolling your balance into another qualified retirement plan, you have 60 days from receipt of that check to deposit the money into a qualified plan yourself. Otherwise, that money would be subject to income tax -- and, if you are under age 59 1/2, it would be subject to a 10 percent penalty as well.
Ask the expert Q: Do I lose 401(k) retirement money if I leave my employer?
How does a 401(k) rollover work?
If you are switching to a new employer that also has a 401(k) plan, you can have the money rolled over from one plan to another without any tax consequences.
Some 401(k) plans now have both traditional and Roth 401(k) features. For tax reasons, it is very important when rolling over to make sure traditional 401(k) balances go into a traditional 401(k) at your new employer, and that Roth 401(k) balances go into a Roth 401(k) plan.
How can I roll a 401(k) into an IRA?
If your new employer does not offer a 401(k) plan, or you are not wild about the plan they do offer, you can have your 401(k) balance rolled over into an IRA.
If you do this within 60 days of leaving the 401(k) plan, you can avoid tax consequences. The best way to do an IRA rollover out of a 401(k) plan is to instruct the plan sponsor to distribute your balance directly to the trustee of your new IRA rather than to send the money directly to you.
As with rollovers to a new 401(k), when making a rollover into an IRA, pay attention to whether the money is coming from a traditional or Roth 401(k). For tax purposes, it is important that the money transfers into the corresponding type of 401(k).
What are the penalties for cashing out your 401(k)?
Suppose you don't want to roll your 401(k) balance into a new retirement plan. What are the tax consequences of cashing out?
The big variable here is your age. If you are under age 59 1/2, it is likely that any distribution from a 401(k) will be subject to a 10 percent penalty, in addition to ordinary income tax consequences.
The ordinary income tax liability depends on the type of 401(k) plan you were in. If it was a traditional 401(k), you will probably owe income taxes on the distribution, even if you are above age 59 1/2. If you are above 59 1/2 and the distribution is coming from a Roth 401(k), there should not be any immediate tax consequences. However, any subsequent investment returns would be subject to taxation.
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What happens if I do nothing?
If you have less than $5,000 in the 401(k), the administrator can remove your assets from the plan without your consent and most plans are set up to do exactly that. They can transfer your money into an IRA on your behalf, but this will mean passively accepting an investment option and fees that were not of your choosing.
Worse, if your balance is less than $1,000, the plan can simply send you a check in the amount of your balance. This could subject that money to income taxes and penalties if you do not quickly deposit it in a qualified retirement plan.
Ask the expert Q: Why are federal and state reporting of 401(k) deferrals different?
Why should I consolidate 401(k) balances?
Considering your options, there are three ways you can avoid tax consequences when leaving an employer's 401(k) plan: You can leave your balance in the prior employer's plan (if permitted); you can roll it into your new employer's 401(k) plan; or you can roll it into an IRA.
There is a strong argument to be made for rolling into the new employer's 401(k) plan. This may allow you to consolidate your existing 401(k) balance with future contributions. That consolidation might allow you to take a coordinated approach to asset allocation, retirement planning, and investment-performance monitoring.
What else should I consider when rolling out of a 401(k) plan?
Besides the tax implications discussed in the preceding slides, you should consider the characteristics of the retirement plan options available for your rollover.
Specifically, consider the range of investment choices and the fee levels involved. A new employer's 401(k) plan might well offer a greater range of investment capabilities and more cost efficiency than an IRA you could set up on your own. On the other hand, you may value the flexibility to choose your own provider.
What are the next steps I should take?
Once you have made a decision about where you want your 401(k) balance to go, do the following:
- Ask the 401(k) plan administrator at your current employer about their distribution/rollover procedures.
- Provide the 401(k) plan administrator at your current employer with clear, written instructions about where you want the money to go.
- Make sure the institution that will be receiving your 401(k) rollover gets a copy of those instructions too.
- Check to see that the balance was received once you make the move to your new employer.
If possible, line up as much of this as you can before your last day of work, because timing is crucial.
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