It’s common for people to change jobs and sometimes try an entirely new career. The average American has around twelve different jobs in their lifetime. Successful people change employment on average every three to five years. But what happens to your 401(k) when you quit?
It would be annoying to keep track of multiple 401(k) retirement accounts and inconvenient for retirement planning. There will also be more tax forms and other documents to complete and file. So what can you do with your 401(k) when you quit? The following is a list of options to explore when you leave a job that has a 401(k) plan.
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How Does a 401(k) Work?
A 401(k) is a retirement plan offered by employers. The plan provides tax benefits and allows employers to set up a contribution-matching program to support retirement savings. Workers can automatically transfer a specific amount from every paycheck into the 401(k), and the employer matches the contribution based on the allowable limits. How much you have in your 401(k) will vary on circumstances, but you may build substantial wealth. But what happens to the 401(k) plan if you quit your job or change employers?
What Happens to Your 401(k) When Quit and Change Jobs?
Option 1: Leave it With the Former Employer
You can leave the 401(k) with the current employer if you have at least $5,000 in the plan. For amounts lower than $5,000, the employer may roll it over into an Individual Retirement Account (IRA) or even send you a check. Understand the company’s policies to help you make a more informed decision, as you don’t want to pay any taxes or penalties on any amount removed from the account. Also, consider whether the fees are reasonable and the investments are doing well. The benefit of leaving the plan is that it will continue to grow in a tax-deferred account. However, you won’t be allowed to further contribute to the plan.
Also, if your 401(k) includes shares of the former company’s stock, talk to a tax professional to see what you can do about those assets and how you can keep their tax benefits.
Many times experts do not prefer this choice because of future potential headaches. Timothy Uihlein, CFP®, MBA, of Vincere Wealth Management, says,
“Unless the current 401(k) is very robust, we almost always recommend to our clients to either roll the plan to their current company’s 401(k), if they have one and the plan allows for rollovers, or roll the plan to an IRA, whether they self direct it or whether we manage it. Too often, clients forget about old 401(k)s due to name and/or address changes. In addition, a company can liquidate a former employee’s 401(k) if the balance is under $5,000 creating unnecessary tax headaches for the individual.”
Option 2: Cash Out
You can withdraw your money from the 401(k), but it will no longer be tax-sheltered. If you don’t deposit the funds into another retirement account, you will be subject to paying taxes and penalties for removing the money if you are still under 59-1/2. Not only will you be losing a significant chunk of your retirement savings, but you will also lose any growth the funds would have experienced if they remained in the 401(k). It’s best to keep the option of cashing out off the table.
Option 3: Roll the Money Over into the New Employer’s 401(k)
If you are starting a new job that offers a 401(k) plan, rolling the previous plan in if the new employer allows it is ideal. The main advantage is that you will have everything in one place, which means less paperwork and easier financial management. The general process for rolling over into a new plan is that the former employer will send a check payable to the new retirement account, which must be deposited within 60 days. If you wait any longer, you will be subject to taxes and penalties, as the money will be treated as a complete withdrawal. A better option would be to directly transfer from one 401(k) to the other if possible.
Curtis J. Crossland, MBA, CFA®, CFP®, EA, of Suttle Crossland Wealth Advisors, points out,
“If the old 401(k) has better costs and better investment options, you could just leave it be and monitor it as part of your regular review of accounts. If you have comparable options and costs at the new 401(k) plan, you can do a direct transfer from one plan sponsor to another. The benefit of having the money in a 401(k) that you’re actively participating with relates to borrowing needs. You have largely the same creditor protections, but should the need arise, you can only borrow from a 401(k) you’re active with.”
There are two other things to consider before moving your former employer’s 401(k) over to the new one.
1. Complete the Probationary Period
Wait until you complete your probationary period at the new place of employment. It’s also possible that the new employer won’t start your retirement plan until you pass your probation anyway.
2. Check the Plan’s Vesting Period
Vesting means that all the employer’s contributions to your plan are 100% yours. The money must remain in the plan, and you must be an employee of the company for full ownership for a certain period. This information should be outlined in your employee handbook.
If some money is not vested, you can still roll your plan over because your contributions still belong to you. But you may have to return part of the money to the employer if you didn’t fulfill the vesting requirements.
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Option 4: Roll the Money Over into an Individual Retirement Account (IRA)
If the new employer doesn’t offer a 401(k) plan or you don’t want another same account, you can roll the money into a traditional IRA. The transfer to an IRA can actually provide you with more investment opportunities that may have been limited by the previous employer.
Again, completing a direct transfer from 401(k) to IRA is best. The other option is to receive a check payable to the new plan and deposit the money within 60 days to avoid any taxes or penalties.
Many financial planners prefer this option. It also alleviates the issue of people or beneficiaries forgetting about a plan years later. According to Angela Dorsey, CFP®, MBA of Dorsey Wealth Management,
“When a person leaves a job, they run the risk of their 401k becoming an ‘orphan 401k’. Meaning they leave their 401k in their employer’s plan and then forget about it. The danger of this is out of sight out of mind…Worse case is they forget they even have a 401k they left behind and find themselves years later scrambling to contact their employer about their 401k or their heirs trying to track down the 401k if they are even aware it exists. The best case as you leave jobs is to consolidate your 401ks into an IRA to simplify your finances.”
Evaluate the Pros and Cons
Americans on average change jobs every few years. Before deciding what happens with your 401(k) when you quit and leave an employer, go through the advantages and disadvantages of each option. The objective of a 401(k) is to grow your wealth and provide financial security at retirement. Make sure this isn’t compromised when making your decision.
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Nadia Tahir is a freelance writer and content creator. She mostly writes in the areas of lifestyle and personal finance. She also enjoys writing on her blog about motherhood at This Mom is On Fire.