Whether you’re taking a new position with another company, retiring or being let go, if you have a 401k or similar retirement plan, you’re probably wondering: What happens to your 401k when you leave a job? That’s really up to you, but you need to explore and weigh your options thoroughly. Even if the amount in your 401k is small, this isn’t a decision to be taken lightly. Read on to understand what your main options are, and find out what to do with your 401k when leaving a job.
Leave Your 401k in Your Old Plan
Leaving your 401k in your old employer’s plan saves you from having to make an immediate choice about what you want to do with your 401k when leaving a job. A temporary decision to leave your 401k in your old plan can turn into a permanent one, so you need to make this choice proactively. Otherwise, you might find yourself with a lot of old 401k accounts you’re not as invested in as you should be.
Before making this decision, there are some things to consider. For instance, if you have less than $5,000 in the plan, your employer might have the ability to automatically distribute your balance to you. If you’re able to do this, you should contact your old employer and discuss your options. Keep in mind that you will most likely have fewer investment options than with an IRA if you stick with the old plan. Also, withdrawal options might be limited and you might have to take the entire account balance versus a partial withdrawal.
Financial advisor Len Hayduchok said the main reason to leave your 401k in an old employer’s plan is if the plan offers an investment opportunity you can’t get elsewhere. As an example, he cited a high-yielding fixed interest account offered in a public employee’s plan. This plan yielded far more than any similar investment in an IRA. Other than situations similar to this, where the investment opportunity is unmatched, Hayduchok always recommends rolling your 401k balance into an IRA.
Roll Your 401k Into an IRA
Rolling your 401k balance into an IRA account with an institution of your choice is a great option. IRA accounts are available with popular banks like Charles Schwab and Fidelity, and many mutual fund companies and brokerage firms offer IRA options as well. Financial advisor Jim Blankenship said that if you have pre-tax and post-tax money in an IRA, you could use the 401k to separate the pre-tax money. This would allow for a tax-free Roth conversion, which could be of benefit to you.
There are a few 401k rollover rules to follow when rolling your 401k into an IRA. For example, make sure that the rollover is done as a trustee to trustee transfer. This means that you never take possession of the money and this is the best way to ensure the tax-deferred nature of the 401k is preserved. Also, make sure you’re aware whether or not your 401k account includes shares of company stock. In this case, you can take advantage of the net unrealized appreciation (NUA) rules which can carry some significant tax advantages.
If you’re working with a financial advisor, an IRA can be a good way to consolidate your retirement plan investments and have them invested in line with your financial plan. One caution here is that there are some brokers and registered representatives who target employees of large organizations trolling for 401k rollover opportunities. They might try to roll the money into high-fee investments that might not be in your best interest.
Overall, an IRA will offer a wider array of investment options including mutual funds, ETFs, closed-end funds, individual stocks and more. Some firms will also allow you to open a self-directed IRA. This type of IRA allows you to invest in non-traditional investments such as real estate, gold and others.
But always use caution before going this route, and be sure you understand the fees and risks. Blankenship said to always know your options and know whether the 401k has superior choices to what you could get on your own, before rolling your 401k into an IRA.
Roll Your 401k Into Your New Employer’s Plan
If you’re switching jobs, rolling your 401k into your new plan might be the best option for you. You’ll need to check with your new employer to see if their 401k plan accepts rollovers, however. If the new plan offers superior investment options, this is definitely a great choice, but there are some other factors to consider.
For example, you’ll want to be sure the new 401k plan allows you to consolidate the money from your old plan and your new one. This leaves you with fewer accounts to worry about, which allows you to focus on investing in one plan. You’ll also want to know if there are any penalties if you leave before you’re 100 percent vested in the company match. If there are penalties, you might receive a larger share of the money with a larger account balance.
Lastly, rolling the old money into the new plan affords greater creditor protection offered by a 401k versus an IRA, under federal law. This could be helpful in certain situations and should be considered as you’re looking into the new plan.
Read More: How Much Will My 401k Be Worth?
Take a Distribution
In most cases, this is the worst option when deciding what to do with your 401k when leaving a job. Taking a distribution subjects your money to taxes at high rates — and if you’re under 59 ½ years old, you’ll incur a 10 percent penalty on top of the taxes due. Additionally, taking a distribution takes money out of your retirement savings, which will cause you to have less money when you finally do retire.
Some exceptions to the 10 percent penalty for those under 59 ½ include instances of death and disability, an IRS levy on your account or a qualified domestic relations order in the instance of divorce. There is also an exception if you’re 55 or older and leave the company at or after age 55. This exception is known as section 72(t), and if it applies to you, it’s best to find a financial advisor who understands the complex rules of this section before making any decisions on your own. Otherwise, taking a distribution is probably the last option you’d want to consider.
Although you have several options regarding your 401k when leaving a job, the choice should not be taken lightly. Even small retirement accounts can add up over time if properly invested. But now that you’ve weighed the options, you can make a well-informed decision as to which approach is best for you and manage your retirement accounts smartly moving forward.