What Happens to Your 401(k) When You Leave a Job?

You have options, but some may be better than others

After you leave your job, there are several options for your 401(k). You may be able to leave your account where it is. Alternatively, you may roll over the money from the old 401(k) into either your new employer’s plan or an individual retirement account (IRA). You can also take out some or all of the money, but that could mean serious tax consequences. Make sure to understand the particulars of the options available to you before deciding which route to take.

Key Takeaways

  • If you change companies, you can roll over your 401(k) into your new employer’s plan, if the new company has one.
  • Another option is to roll over your 401(k) into an individual retirement account (IRA).
  • You can also leave your 401(k) with your former employer if your account balance isn’t too small.
  • Another choice is cashing it out, although this is a last resort.

Leave It With Your Former Employer

If you have more than $5,000 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) with a previous employer 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.

If you leave your 401(k) with your old employer, you will no longer be allowed to make contributions to the plan.

Roll It Over to Your New Employer

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 a 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.

Another good reason to roll over a 401(k) to a new employer—money in the 401(k) of your current employer is not subject to required minimum distributions (RMDs), even when you turn 72 years old. Money in other 401(k) plans and traditional IRAs is subject to RMDs.

Roll It Over Into an IRA

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 possibilities are almost limitless. That is, you’re no longer restricted to the options made available by an employer.

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.

Take Distributions

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 life span and your account balance.

The Internal Revenue Service (IRS) has a handy RMD worksheet to help you calculate the amount that you must withdraw.

Cash It Out

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 probably will be subject to the 10% early withdrawal penalty.

What Happens If You Don’t Roll Over 401(k) Within 60 Days?

For indirect rollovers, you have 60 days to deposit the money into another 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.

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 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 for people born between 1951 and 1959 and age 75 for people born in 1960 or later. 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, you have several options for dealing with your 401(k). For money in a former employer’s 401(k) plan you have to look at all the pros and cons before deciding what to do with it.

Article Sources
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  1. Internal Revenue Service. “401(k) Resource Guide — Plan Participants — General Distribution Rules.”

  2. Fidelity. “Considerations for an Old 401(k).”

  3. Internal Revenue Service. “Topic No. 413 Rollovers from Retirement Plans.”

  4. Internal Revenue Service. “RMD Comparison Chart (IRAs vs. Defined Contribution Plans).”

  5. Internal Revenue Service. “Considering a Loan from Your 401(k) Plan?

  6. Internal Revenue Service via Internet Archive. “Designated Roth Accounts — Distributions.”

  7. Internal Revenue Service. “Here’s What People Should Know About Taking Early Withdrawals from Retirement Plans.”

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