Can You Lose the Rights to Your 401(k)?

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Your employer can’t seize your 401(k) contributions or the investment earnings from those contributions when you change jobs voluntarily or when you get fired or laid off. However, your retirement plan is subject to rules imposed by the company and the IRS. Those rules could limit your rights to the funds in your account.

Here are three factors that can impact what happens to your 401(k) when you leave an organization

Account Balance

The amount of money in your 401(k) plays a significant role in determining what happens to your account when your employment gets terminated. 

Here’s what the company can do at various balance levels:

  • Under $1,000: Cut you a check for the total amount
  • $1,000-$5,000: Move the funds to an employer-selected individual retirement account
  • $5,000+: Leave the money where it is or ask your permission to move it

Legal Update Ahead: The government recently passed the SECURE 2.0 Act, which makes several changes to how retirement accounts get handled. One such change is that the $5,000 threshold mentioned above will increase to $7,000 for distributions processed after Dec. 31, 2023.

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Vesting Schedule

You own every penny of the money you contribute to your 401(k). However, companies can set vesting schedules to determine when you can keep the employer’s contributions to your account should you leave the firm.

Many companies use a tiered vesting schedule, where you earn the right to keep a percentage of the employer match based on your years of service. For example, you may earn 20% each year during years two through six. In that case, you’d need to remain employed for six years to be fully vested, which means you’re eligible to receive all of the company’s contributions upon termination. 

Outstanding Loans

If you take out a 401(k) loan and leave your job before paying it off, your employer will require you to remit the outstanding balance. If you can’t or won’t repay the debt, the loan will be considered a distribution, which is subject to income tax. Plus, if you’re under 59.5, you may have to pay a 10% penalty for early withdrawal.

Best Practices

Before leaving your current position, read your 401(k) summary plan description (SPD), which contains all the rules governing the plan. That way, you’ll know what to expect when your employment terminates.

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Then, decide what you want to do with the money. For example, if your investments are performing well and you can keep the funds in the account, you may want to leave your cash where it is. Otherwise, you might roll the funds over into your new employer’s 401(k) plan or into an IRA.

Depending on what type of rollover you choose, you may be required to pay taxes if the conversion isn’t done in a timely manner. If you do a direct rollover to a retirement plan or to an IRA you will not have to pay taxes or an early withdrawal penalty. The same goes for a trustee-to-trustee transfer from an IRA — as long as the monies are directly deposited into another IRA or retirement fund, you won’t face any penalties. However, if your payout goes directly to you, you have just 60 days from the check date to deposit it into a new retirement account. If you fail to do so within the allotted time, or choose to keep part of the funds for other purposes, taxes will be withheld.

It’s also important to note, you can only do a rollover once per 12-month period. This rule does not apply to direct rollovers or trustee-to-trustee transfers.

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This article was updated to clarify any penalties that could be incurred for the different types of rollover options.

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