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When you leave a job, you have several choices of what to do with your 401(k), each with different benefits and tax implications. You may be able to leave your account with your former employer, roll it into an individual retirement account (IRA), or move it to your new employer’s plan.
Cashing out is also an option, but doing so can trigger significant taxes and penalties if you’re not yet eligible for penalty-free withdrawals. Here are the choices available.
Key Takeaways
- You can leave your 401(k) with your former employer if the balance exceeds $7,000.
- Rolling a 401(k) into an IRA offers more investment choices if a new employer’s plan isn’t available.
- Indirect rollovers involve a 60-day deadline to avoid taxes and penalties.
- Cashing out a 401(k) can lead to taxes and penalties, reducing retirement savings.
- Avoid required minimum distributions by rolling 401(k) funds to a new employer’s plan
Transfer Your 401(k) to a New Employer’s Plan
If you have more than $7,000 invested in your 401(k), most plans allow you to leave it where it is after you separate from your employer. If you have a substantial amount saved and like your plan portfolio, then leaving your 401(k) in the account may be a good idea. If you are likely to forget about the account or are not particularly impressed with the plan’s investment options or fees, consider some of the other options.
Important
If you leave your 401(k) with your old employer, you will no longer be allowed to make contributions to the plan. It will still be invested as it was and you can work with the 401(k) provider to change your investments if you so choose.
Move Your 401(k) to an IRA Account
If you’ve switched jobs, see if your new employer offers a 401(k), when you are eligible to participate, and if it allows rollovers. Many employers require new employees to put in a certain number of days of service before they can enroll in the company’s retirement savings plan. Make sure that your new 401(k) account is active and ready to receive contributions before you roll over your old account.
Once you are enrolled in a plan with your new employer, it’s simple to roll over your old 401(k). You can elect to have the administrator of the old plan deposit the balance of your account directly into the new plan by simply filling out some paperwork. This is called a direct transfer, made from custodian to custodian, and it saves you any risk of owing taxes or missing a deadline.
Alternatively, you can elect to have the balance of your old account distributed to you in the form of a check, which is called an indirect rollover. You must deposit the funds into your new 401(k) within 60 days to avoid paying income tax on the entire balance and an additional 10% penalty for early withdrawal if you’re younger than age 59½. A major drawback of an indirect rollover is that your old employer is required to withhold 20% of it for federal income tax purposes—and possibly state taxes as well.
Fast Fact
Another good reason to roll over a 401(k) to a new employer is that the money in the 401(k) of your current employer is not subject to required minimum distributions (RMDs), even when you turn 73 (or 75, depending on when you were born). Money in other 401(k) plans and traditional IRAs is subject to RMDs.
Access Funds From Your 401(k)
If you’re not moving to a new employer, or if your new employer doesn’t offer a retirement plan, you still have a good option—you can roll your old 401(k) into an IRA. You’ll be opening the account on your own, through the financial institution of your choice. The best IRAs offer a good customer experience and more.
Warning
If you have an outstanding loan from your 401(k) and leave your job, you’ll have to repay it within a specified time period. If you don’t, the amount will be treated as a distribution for tax purposes.
Withdraw Your 401(k) Funds
You can begin taking qualified distributions from any 401(k), old or new, after age 59½. That is, you can start taking some money out without paying the 10% tax penalty for early withdrawal.
If you’re retiring, it might be the right time to start drawing on your savings for income. With a traditional 401(k), you must pay income tax at your ordinary rate on any distributions that you take.
If you have a designated Roth account, any distributions that you take after age 59½ are tax-free as long as you have held the account for at least five years. If you do not meet the five-year requirement, only the earnings portion of your distributions is subject to taxation.
If you retire before age 55 or switch jobs before age 59½, you may still take distributions from your 401(k). However, you will be required to pay a 10% penalty, in addition to income tax, on the taxable portion of your distribution—which may be all of it. The 10% penalty does not apply to those who retire after age 55 but before age 59½.
Once you reach the age of 73 (for those born between 1951 and 1959; the age of 75 for those born in 1960 or later), you are required to begin taking RMDs from your 401(k) when you leave your job. Your RMD amount is dictated by your expected lifespan and your account balance.
$7,000
The minimum amount that must be invested in your 401(k) in order to be allowed to stay there after you separate from your employer.
Cash Out Your 401(k)
Of course, you can just take the money and run. Nothing is stopping you from liquidating an old 401(k) and taking a lump-sum distribution, but most financial advisors caution strongly against it. It reduces your retirement savings unnecessarily, and on top of that, you will be taxed on the entire amount.
If you have a large sum in an old account, then the tax burden of a full withdrawal may not be worth the windfall. Plus, you may be subject to the 10% early withdrawal penalty.
What Happens If You Don’t Roll Over Your 401(k) Within 60 Days?
For indirect rollovers, you have 60 days to deposit the money into another 401(k) plan or IRA. If you fail to do so, the money will be taxable and you will likely face an additional 10% early withdrawal penalty. This is commonly referred to as the 60-day rollover rule.
What Is a Direct Rollover?
A direct rollover allows you to transfer funds from one qualified retirement account (such as a 401(k) plan) directly into another (such as an IRA). The distribution is not made to you—instead, it is issued as a check or wire transfer made payable to the new retirement account.
What Is a Required Minimum Distribution (RMD)?
A required minimum distribution (RMD) is the amount that must be withdrawn from an employer-sponsored retirement plan, such as a 401(k), or a traditional IRA after you reach age 73 between 2023 and 2032. The age increases to 75 in 2033. If you are still working, you don’t have to take RMDs from your current employer’s 401(k) plan.
The Bottom Line
If you leave your job, your 401(k) will stay where it is until you decide what you want to do with it. You have several choices, including leaving it where it is, rolling it over to another retirement account, or cashing it out, though cashing out may come with taxes and penalties. Comparing fees, investment choices, and potential tax consequences can help you decide what to do with your old 401(k).