Leaving a job can be an exciting, nerve-wracking, or even bittersweet experience. Amidst the excitement of new opportunities or the stress of an uncertain future, an important aspect often goes overlooked: what happens to your 401(k) or similar retirement accounts?
Your 401(k) is a crucial part of your financial future, and understanding your options when you leave your job can have a significant impact on your retirement savings.
Understanding Your 401(k) Balance and Vesting
When you contribute to a 401(k), you and your employer may add funds to your account. However, only some of the money in your 401(k) is immediately yours if you decide to leave your job. The key concept here is vesting. Your contributions to your 401(k) are always 100% vested, meaning they’re yours to keep regardless of when you leave. However, the contributions your employer makes on your behalf may be subject to a vesting schedule.
A typical vesting schedule might allow you to own 20% of your employer’s contributions after the first year, 40% after the second year, and so on, until you’re fully vested after, say, five years. If you leave before you’re fully vested, you only take the vested portion of your employer’s contributions with you; the rest stays with the employer.
Your 401(k) Options When You Leave Your Job
When you leave a job, you have several options regarding what to do with your 401(k). Your decision should depend on factors such as your future financial goals, the balance of your account, and the policies of your former and future employers. Here’s a breakdown of your main options:
1. Leave Your 401(k) with Your Former Employer
If your vested balance is $7,000 or more, most plans allow you to leave your 401(k) with your former employer. This option is particularly convenient if you’re satisfied with your old plan’s investment options and performance. Your account will continue to grow tax-deferred, and you can still manage your investments. However, you won’t be able to make any new contributions.Pros include no immediate required action, potentially lower fees compared to an IRA, and continued tax-deferred growth.
Cons from this option include the potential to lose track of the account over time, limited investment options, and potential difficulties in managing multiple accounts if you change jobs frequently.
2. Roll Over Your 401(k) to a New Employer’s Plan
If your new employer offers a 401(k) plan and accepts rollovers, you can transfer your old 401(k) into your new plan. This approach can simplify your retirement savings by consolidating your accounts, making it easier to manage your investments. A direct rollover, where the funds are transferred directly from your old plan to your new one, is the most straightforward way to avoid taxes and penalties.Pros from this option include a consolidated retirement savings in one account, potential access to better investment options or lower fees, and continued tax-deferred growth.
Cons include that your plan may have limited investment options and rolling over could incur administrative fees.
3. Roll Over Your 401(k) into an IRA
If your new employer doesn’t offer a 401(k), or if you prefer more investment flexibility, rolling your 401(k) into an Individual Retirement Account (IRA) might be the best option. IRAs typically offer a broader range of investment choices, including stocks, bonds, and mutual funds. You can also continue contributing to your IRA if you have earned income.Pros include having access to a wide range of investment options, the ability to continue contributions, and potential for lower fees compared to a 401(k).
Cons include being required to managed the account yourself or pay a financial advisor, potential to pay higher fees for some IRAs compared to employer-sponsored plans, and that the rollover process requires careful management to avoid taxes and penalties.
4. Cash Out Your 401(k)
This option should be approached with caution. If you cash out your 401(k) before age 59½, you’ll owe income taxes on the distribution and may be hit with a 10% early withdrawal penalty. Additionally, cashing out reduces your retirement savings, significantly impacting your retirement financial security.The pro here is that you’ll have immediate access to cash. However, the cons include facing heavy tax burden and potential penalties, experiencing a significant reduction in retirement savings, and losing tax-deferred growth potential.
Considerations for Special Circumstances
When transitioning from one job to another, certain factors can affect how you manage your 401(k) and retirement savings. Whether it’s handling an outstanding 401(k) loan, addressing small account balances, or preparing for required minimum distributions (RMDs) as you near retirement, these unique circumstances require careful attention to avoid unnecessary taxes or penalties. Understanding these considerations can help ensure a smoother financial transition during this period of change.
1. Outstanding 401(k) Loans
If you’ve taken a loan from your 401(k) and left your job, you may need to repay the loan within a specified period. Failure to repay the loan could result in the loan amount being treated as a distribution, subject to taxes and penalties.
2. Small Account Balances
If your vested 401(k) balance is less than $1,000, your former employer may cash out the account or roll it into an IRA. For balances between $1,000 and $7,000, your employer might roll the funds into an IRA or your new employer’s plan.
3. Required Minimum Distributions (RMDs)
If you’re approaching retirement age, remember that once you turn 73 (or 75, depending on when you were born), you must start taking minimum distributions from your 401(k). However, RMDs don’t apply to your current employer’s 401(k), which is something to consider when deciding whether to roll over your account.
Steps to Take Before Leaving Your Job
To ensure a smooth transition of your 401(k) or other retirement accounts when leaving a job, consider these steps:
1. Gather Information
Before your last day, ensure you have all the login information and contact details for your retirement accounts. Contact HR to see if they provide an exit packet with these details.
2. Understand Your Vested Balance
Knowing how much of your 401(k) is vested will determine how much you can take.
3. Plan for Your 401(k) Loan
If you have a loan from your 401(k), check the repayment terms and make arrangements to avoid penalties.
4. Compare Options
Consider each rollover option’s fees, investment options, and potential tax implications. A financial advisor can help you make an informed decision.
Making the Right Decision
Deciding what to do with your 401(k) when you leave a job is a critical decision that can have lasting effects on your financial future. Take the time to explore each option and consider your long-term retirement goals. Whether you leave your account with your former employer, roll it over to a new plan or IRA, or cash it out, the key is to make a decision that aligns with your financial strategy.
If you’re feeling uncertain or overwhelmed, consulting with a financial advisor can provide clarity and help you navigate the complexities of retirement planning.
Your 401(k) is a valuable asset—making the right choice now can set you toward a secure and comfortable retirement.
