Most Americans today have an average of 12 jobs in their lifetime. Gone are the days of getting a job straight out of school and staying there until the day you retire. With moving jobs often comes the question, “what should I do with my old 401(k)?” Most people don’t want 12 retirement accounts sitting around. You’ll want to ensure you are setting yourself up for financial success in retirement. Deciding what to do with your retirement plan when you quit your job is an important decision to make.
In this article, we will discuss your top 4 options on what to do with your old 401(k) when you leave a job.
Before we get into the details of what happens to your 401(k) when you leave a job, let’s start with some basics of the 401(k). Many people have access to a 401(k) retirement plan. This is a plan offered through an employer and allows employees to save either pre-tax (traditional) or post-tax (Roth) money out of their paychecks each month. Many employers also offer a matching contribution to their employee’s 401(k) accounts. 401(k) accounts have limits on what the employee can add, and the total that can be contributed to the account during each tax year.
One important term to know when leaving an employer is the term “vesting.” You may have heard about it or read about it in your employee handbook when you began your job. Vesting is the time at which the money the employer placed into your 401(k) (or other retirement accounts) becomes fully your money. The money that you as the employee add to your account is always yours, there will be no vesting schedule placed on money you add from your paycheck deferrals.
Here is an example of Vesting: Let’s say your employer makes a 5% matching contribution to your 401(k). This means that if you put 5% of your salary into your 401(k), your employer also adds the same amount to your 401(k) out of their pocket. Now let’s say the employer says you will vest in your 401(k) 20% per year of employment. This means that if you left your job after 2 years, you would be vested in 40% of the money the employer added over that 2 years. When you leave, you would forfeit 60% of the funds the employer matched over the time you were employed.
In order to be fully vested in the employer match in the example above, you would have to remain at that job for 5 years. The longest an employer can make you wait to be fully vested is 6 years. Many employers have shorter vesting periods, and many have none at all, meaning once they add the money to your 401(k), it is yours when you leave the job.
Now that you know the basics of a 401(k) and what vesting means, let’s discuss your options for the 401(k) when you leave your job.
Option 1: Leave the money with your former employer’s 401(k)
If you have at least $5,000 in the plan when you leave the job, you can keep the money where it is. If you have between $1,000 and $5,000 in the plan, the employer can either allow you to remain in the plan, or they can roll your 401(k) funds into a rollover IRA for you. If you have less than $1,000 in the plan when you leave, the employer can allow you to leave your money in the plan, but they are also allowed to cut you a check for the full amount in the account.
If you do have less than $1,000 in the 401(k) when you leave the employer, it is important that you find out if they will automatically send you a check. If that is the case, you will need to act quickly to get those funds into another retirement account to avoid paying taxes and penalties on this amount. While $1,000 seems small, it can add up, and we don’t want to pay the IRS more than we have to.
So when is it a good idea to leave funds with an old employer 401(k)? Consider the investment options and fees in that plan. If the fees are low and investment options are good, you may want to consider keeping your money where it is. You can start contributing to your new plan with your new employer while the money in your old 401(k) plan is left to grow.
Option 2: Roll it over to your new employer’s 401(k)
You have the option of rolling your old 401(k) into your new plan. This may make sense if your new 401(k) has better investment options and lower fees than your previous employer’s 401(k) plan. Or maybe you really just do not like the idea of having multiple 401(k) plans and prefer to have your money in one place.
Now, if you have some Roth and some traditional money in your previous 401(k), this can get tricky. You will want to make sure your new plan can accept Roth money.
If you decide that rolling your old 401(k) funds to your new 401(k) is the best option for you, you may want to choose a Direct Transfer of funds from one account to the other, if available. This allows the old company to send the check directly to the new 401(k) plan so it never comes directly to you.
If you choose a Rollover, the old company will send you a check for the funds, and you will have 60 days to get that money into your new plan before the IRS treats it as an early withdrawal. If that happens, you will pay taxes and penalties on the funds, which can be a costly mistake. I have known people who set the check aside and forgot about it. You don’t want this to happen.
Option 3: Roll into an IRA
If you have decided that you do not want to keep the money in the old 401(k) plan, but maybe you don’t have access to a 401(k) plan with a new employer or maybe the new plan just doesn’t have the best investment options and fees, you can choose to roll the 401(k) into an IRA.
The same cautions as above apply here. Make sure you do a direct transfer and not a rollover where they send you a check first.
You may want to choose an IRA that has lower fees and access to better investment options than your 401(k), otherwise the move might not make much financial sense.
The main advantage of rolling it over into an IRA is you typically will have significantly greater investment options at your fingertips. If you roll it into an IRA with a brokerage firm, you can buy any stock, ETF or mutual funds. The downside is you will have to truly understand what you’re investing in, otherwise it may backfire.
If you’re planning to do a backdoor Roth IRA, then having a new rollover IRA may complicate things for you. Check out our video on how to do a backdoor Roth IRA for more information.
Option 4: Cash it Out
Most people know that this is not usually the best option when leaving an employer, but it can still be tempting to cash out your 401(k). If you take the money out of the plan before age 59.5, you will likely incur a 10% tax penalty PLUS income taxes on any traditional money you are cashing out.
Not only does this tax penalty take away a chunk of your retirement savings before you get to use it, but taking the money out before you are ready to retire stops the potential growth of that money from now until retirement. The growth can add up! $5,000 invested at a rate of 5% for 25 years adds up to over $16,000. Instead of cashing out that $5,000, paying the IRS, and spending the rest, you may want to leave your retirement money earmarked for retirement, and your future self will thank you!
Some additional questions you may have about your 401(k) when you leave a job:
Can I cash out my 401(k) if I quit my job?
You can cash out your 401(k) if you quit your job but it’s often not a great idea given the amount of taxes you’ll have to pay plus a 10% penalty. You will need to contact your plan administrator and fill out certain forms to gain access to your 401(k) funds.
How long do you have to move your 401(k) after leaving a job?
You don’t have to move 401(k) after you leave a job. You can just keep it there if you’d like. But if you initiate a rollover after you leave your job and they mail you a check, then you have 60 days to roll over these funds into an eligible retirement account. If you don’t do it within 60 days, then you may be subject to early withdrawal taxes.
How to transfer 401(k) to a new job
If you want to transfer your 401(k) to your new employer then you must contact both your old and new 401(k) plan administrator. Your new 401(k) plan administrator can confirm if they will accept the transfer, and can give you the details you need for the rollover. You will likely need to fill up a rollover form with your old 401(k) plan administrator to initiate the transfer.
How to cash out 401(k) from an old job
To cash out your 401(k), you must contact your plan administrator for the paperwork, fill it out, send it to the financial institution that manages your 401(k). Once it is approved, you should receive a check in the mail within a couple of weeks. Please be aware that this will generate lots of taxes and a 10% penalty.
How long does it take to cash out 401(k)?
When you request to cash out your 401(k), it generally takes one to two weeks to get the funds. However, depending on the employer and the amount of funds, it can take longer than two weeks.
So what happens to your 401(k) when you leave your job?
You can 1) leave the money in your old 401(k), 2) roll it over to your new employer’s 401(k), 3) Roll it into an IRA, or 4) cash it out. Each has its pros and cons. We recommend you speak to a financial planner who can assist you in making the best decision for your prior plan. Schedule a complimentary call with one of our credentialed financial planners here.
Kayla Welte, AFC®, ChFC®, CFP®, has been helping clients across the country maximize their finances since 2009. With a background in financial education and counseling, Kayla is passionate about helping people prioritize and reach their financial goals. Kayla is a Financial Planner with District Capital Management, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call today.