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Thursday, December 07, 2023

What happens to your 401(k) if you quit your job?

What happens to your 401(k) if you quit your job?

person holding work bag

Key takeaways

There are several options available: staying in your former employer’s plan, rolling over to an IRA and others. What you choose to do will depend on your unique financial situation and goals.

11.12.2021

Moving on to bigger and better things in your career?

If you quit your job at your current company, there are a few options for what to do with your 401(k). Unlike an Individual Retirement Account (IRA), 401(k)s are sponsored by employers. And if you are one of the millions of Americans who contribute a portion of your salary each pay period to a 401(k) retirement savings plan, you’re probably wondering: What happens to my 401(k) when I quit my job or leave my company?

The average American will hold 10 different jobs before reaching the age of 40, according to the Bureau of Labor Statistics.1 If the average person participates in a 401(k) plan at just a few of the jobs where they work, then they’ll have to decide what to do with the 401(k) assets held in accounts each time they leave one job to start a new one.

With all the news lately around “the Great Resignation,” with more and more workers opting to walk away from their jobs after a year of working from home, it’s important for people considering this to know what to do with their 401(k) plans.2

What happens to your 401(k) when you leave a job?

Unfortunately, many people choose not to make a decision about what to do with their 401(k) funds. Instead, they simply leave the funds behind in their former employer’s 401(k) plan.

Most plans allow former employees to leave funds in their account if the account contains more than $5,000. If there’s less than $5,000 in the account, the plan sponsor may rollover the account to an IRA in the former employee’s name or, if the account is less than $1,000, issue the former employee a check in order to close out the account. While leaving money behind in a former employer’s 401(k) might be the easiest thing to do, it’s not always the best option. People often fail to monitor accounts held at former employers as closely as they should — the money becomes “out of sight, out of mind.” This problem can worsen if an individual ends up leaving money behind in several different former 401(k)s.

Also, one of the benefits of a 401(k) plan is an employer match if the company offers one. Once you leave a job where you have a 401(k), you can no longer make contributions to the plan and no longer receive the match. There may be better investment vehicles out there — 401(k) plans may have higher fees, limited investment options and strict withdrawal rules.

Consider all your options and their features and fees before moving money between accounts.

Other options to consider

There are several options available to you in addition to staying in your former employer’s plan, including the following:

Roll over the money into your new employer’s 401(k) plan

If your new employer offers a 401(k) plan with low costs and a wide variety of investment options, this might be a viable option to consider.

If you are interested in rolling the money over into your new employer’s 401(k), meet with the HR department or retirement plan representative to find out more about your new company’s plan. See whether you will be allowed to participate as soon as you’re hired or will have to work for a certain number of days before you’re eligible.

To accomplish this rollover, instruct the administrator of your former employer’s 401(k) to roll over your assets to your new employer’s plan once your account has been established. Alternatively, you can instruct the former employer’s 401(k) administrator to send you a check — but you must deposit the funds into your new employer’s plan within 60 days to avoid paying income taxes and a potential penalty on distribution.

Roll over your old 401(k) money into an IRA

If your new employer doesn’t offer a 401(k), or you’re not pleased with the plan’s costs or investment options, this may be a good option because it will give you flexibility and control to stay on track with your retirement savings goals. IRAs generally have more investment options, no or low administration fees and greater withdrawal flexibility.

In order to execute a rollover to an IRA, your first step is to open a new IRA with a financial institution if you don’t already have one. The rollover process is similar to the one described above except that you have to instruct the administrator of your former employer’s 401(k) to rollover your plan assets to your IRA.

Conversely, you can have a check sent directly to you. The former plan administrator will withhold 20% of the amount for the payment of taxes and you will have 60 days to deposit the full balance, including the 20% withheld, into your IRA. Failure to deposit the entire amount into your IRA could result in current tax liabilities plus a 10% penalty if you’re younger than 59½ on the amount that was not deposited in your IRA.

Take a lump-sum distribution

You can also choose to simply cash out the account by receiving a lump-sum distribution of the money in your former employer’s 401(k). However, you should be aware that you’re not going to receive the full balance in your account because you will have to pay not only income taxes, but also a 10% penalty if you are under a certain age. In fact, taxes and penalties could consume up to half of the account’s value, depending on your tax bracket.

This is one reason why many advise against taking a lump-sum distribution from a former employer’s 401(k) plan. This strategy could also jeopardize your retirement financial security by diverting funds from retirement savings where any investment growth will continue to be on a tax-deferred basis.

Start making qualified distributions

If you meet the age requirement, you can begin making distributions from your former employer’s 401(k) plan. While you won’t be assessed a 10% penalty on these distributions, you will have to pay income taxes at your current ordinary income tax rate if the distributions are made from a traditional 401(k).

Our take: Start planning now

If you have an old 401(k) plan or are about to leave a job where you contributed to a 401(k), give some thought now to how you will handle the money in your account. A rollover to an IRA may be a good option for most people, but a financial advisor can help you determine what’s right for your specific situation.

1 Bureau of Labor Statistics, “Number of jobs, labor market experience, marital status, and health: results from a national longitudinal survey,” August 2021.

2 ABC WNEP, “The Great Resignation: Local companies pivot to attract employees after record 4 million across America quit their jobs this spring,” July 2021.

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Kyle Ryan

Kyle Ryan

Contributor

Kyle Ryan is a member of the Empower Advisors Investment Committee. He also serves as Executive Vice President responsible for Empower Personal Wealth LLC sales, client service, and investment operations. Previously, Kyle held senior management positions within Merrill Lynch and Fisher Investments. While at Fisher, he was responsible for managing nearly every aspect of the organization, including all global trading operations, investment research, portfolio implementation, and high net worth sales. Kyle graduated with honors from the University of California – Los Angeles.

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