401(k) Options
When You Leave Your Job
For many people, their 401(k) plan is their primary retirement savings vehicle. When you leave your job it's critical that you have a plan for this money. With the decline of pension plans, especially in the private sector, 401(k) plans often make up a significant portion of a person's retirement nest egg. Roger Wohlner, author of this article in InvestorJunkie offers some guidance.

What Is a 401(k) Plan?
A 401(k) plan is a form of a defined contribution retirement plan. This means that your benefit is “defined” by the amount you contribute plus the amount of employer matching contributions (if any) and by the profit or loss on your investments.
  • Traditional 401(k) accounts let you contribute without paying taxes on the contributions. But you pay tax on later withdrawals.
  • Some 401(k) plans offer a designated Roth account. With this, you make contributions with after-tax dollars, and withdrawals are tax-free if certain conditions are met.

Today, workers generally change jobs a number of times throughout their working careers. Whether you are changing jobs or leaving your job for another reason (such as retirement), you have several options for handling your 401(k). It's important to make a choice regarding this money.

What Happens to Your 401(k) When You Leave Your Job?
You have several options for your 401(k) account when leaving your job.

  • Note that if your balance is under $1,000 your employer can generally force you out of the plan. If this is your situation contact your plan's administrator to see if they will allow you to roll the money over to an IRA or a new employer's plan. This avoids being cashed out and incurring unwanted income taxes and potentially a 10% penalty as well.
  • If your balance is between $1,000 and $5,000, they are allowed to move your account to an IRA account outside of the plan.
  • Beyond these situations, you have several options for your 401(k) account when leaving a job. (See below.)
  • If your employer matched your contributions, that money may or may not belong to you. Most plans have a vesting schedule for the employer match. A typical schedule vests 20% per year, with the employee being fully vested in the employer's matching contributions after five years.

If you leave the company before you are fully vested, you lose the value of any unvested employer matching contributions. Your own contributions are always yours to keep.

Four Main Options for Your 401(k) When Leaving Your Job
When leaving your job there are four main options for your 401(k) account.

1. Leave It With Your Former Employer If your account balance is $5.000 or more, most plans allow you to leave your 401(k) money in the plan when you leave the company.

If your old employer's plan offers a menu of low-cost, top-notch investment choices, leaving your money there makes sense. Otherwise, it may be better to consider other options.

Another consideration surrounds your ability to manage your retirement savings. If you change jobs numerous times over your working career, it's easy to accumulate a number of old 401(k) accounts. This makes managing these accounts and implementing an overall retirement investment strategy difficult. It's recommended to use personal finance software to properly manage your retirement savings.

2. Roll It Over to a New Employer
If your new employer's 401(k) plan accepts rollovers, this could be a good option for your old 401(k) account.

This option allows you to consolidate your old 401(k) money into your new employer's plan. And it eliminates one more retirement account to worry about. If you are nearing the age when required minimum distributions (RMDs) kick in, you may be able to defer taking RMDs on this money while working there. This depends on your not owning 5% or more of the company and this new employer having made the proper plan elections.

A key factor to consider is the quality of the investments in your new employer's plan. If the plan investment menu is not top-notch, consider an alternative for the money in your old account.

3. Roll It Over to an IRA
Rolling your 401(k) balance over to an IRA account when leaving your job is often your best option. An IRA offers far more investment options than a 401(k) plan. These include a full range of exchange-traded funds (ETFs), mutual funds, individual stocks, and other options. And investing in an IRA often costs less than investing in a 401(k) plan.

Consolidate your retirement investments from old 401(k) accounts into one IRA. Having all of your retirement savings (aside from your current 401(k) plan with a new employer) in one place makes implementing your retirement investing strategy easier than having scattered retirement accounts.

4. Taking Distributions/Cashing Out Your 401(k)
This is generally not your best option unless you have an urgent need for the money.

  • Distributions from a traditional 401(k) are taxed. And if you are under age 59½ they are subject to a 10% penalty.
  • Distributions from a designated Roth 401(k) account will not be taxed if you are at least age 59½ and have met other conditions including the five-year rule. Otherwise, any gains in the account may be taxed and subject to a 10% penalty. Your own contributions are not subject to taxes or a penalty.

You can take a distribution from your 401(k) account when leaving your company without incurring the 10% penalty as long as you are at least age 55. Taxes would still be due on the distribution. There are specific IRS rules to be followed here.

Another option that will allow you to avoid the 10% penalty if you are under age 59½ is taking a series of substantially equal withdrawals under IRS section 72(t). This allows for distributions to take place as a series of withdrawals that must last for a minimum of five years or until you reach age 59½, whichever is longer. While the penalty is waived, you still pay tax on the distributions.

Make Sure You Do Something With Your 401(k)
Your 401(k) money represents an important component of your retirement savings. It's critical that you manage this money effectively both while you are working for an employer and when you leave.

You have several choices for this money when you leave your job. It's important to make an affirmative decision for this money whenever you leave a job. This can be the difference between achieving your retirement goals and falling short.




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