Have you changed jobs recently or plan to in the future? If you have a 401(k) or a retirement savings account through your employer, you might wonder what happens to those funds when you leave the company.
The good news is that the money that you contribute to your 401(k) account is all yours. Contributions made by your employer are yours too, as long as you meet any vesting requirements.
And, you have several choices for what to do with your retirement savings after you leave a company. Below are the three main options, along with a summary of pros and cons to keep in mind for each.
1. Keep your retirement savings with your former employer
The first option is a simple, hands-free one: You can keep your 401(k) savings with your previous employer, where they continue to administer the management of the 401(k).
Though it seems like the easiest, it’s not always the best choice for everyone. It’s worth checking with the 401(k) provider to see if they even allow it, as well as what their portfolio fees and options are. For example, if your vested account balance is $5,000 or less, some providers will require you to move the money elsewhere. And, your all-in fees might be expensive—in which case you could probably find a lower-fee option.
Last, if you’re like the average millennial, you’ll likely change jobs several times throughout your career. Having multiple 401(k) accounts with multiple companies may be difficult to keep track of.
- Your savings will continue to grow tax-deferred
- Takes little effort; you can simply leave your 401(k) funds as-is
- You are eligible to take penalty-free withdrawals if you separate from the employer sponsoring your 401(k) account in the year you reach age 59 1/2 or later
- Your former employer or the 401(k) provider may not allow you to keep your retirement savings in your 401(k) account if your balance is below a certain amount
- You cannot make additional contributions to that 401(k) account, since you are no longer an active employee
- Your 401(k) savings may be spread out and hard to manage if you leave multiple accounts with multiple former employers
- Your former employer’s 401(k) plan may have high investment and administrative fees
- Your investment options will be determined by your former employer’s plan
- You may not have access to loans and hardship withdrawals
2. Roll over your 401(k) into an IRA
A popular option is to move your 401(k) funds to a traditional IRA, where it would continue to be tax-deferred. Additionally, you can roll over multiple 401(k) accounts into a single IRA, which can make accounting and recordkeeping much easier.
You may also roll over your old 401(k) to a Roth IRA, if you have Roth 401(k) funds. You can also “convert” traditional 401(k) funds to Roth. But, while earnings would grow tax-deferred and could eventually become tax-free, any pre-tax amount would be taxable in the year you take the distribution from your 401(k) account. This could decrease the actual amount you would be able put into the Roth IRA.
With an IRA, you may have access to broader investment choices (instead of those dictated by your former employer’s plan. Also, if you’re under 59 ½ you can avoid the 10% early distribution penalty for pre-59 ½ distribution on withdrawals for certain reasons, including a first-time home purchase (up to $10,000).
The cons? There may be some additional requirements when withdrawing funds. For example, if you have a traditional IRA, after age 70 ½, you’re required to take annual required minimum distributions, even if you’re not yet retired.
- Your money can continue to grow tax deferred
- You can consolidate multiple tax-deferred retirement accounts into one IRA, which can be easier to manage
- You may be able to withdraw your funds penalty free for certain reasons, even if you’re under the age of 59 ½
- Unlike many 401(k)s, you cannot take a loan from your IRA
- Fees and expenses could potentially be higher than in your former employer’s plan
3. Roll over your old 401(k) to your new employer’s retirement plan
A third popular option is to move your 401(k) from your previous employer’s 401(k) to the new one. This too has some pros and cons. If you plan to stay at your new company for a long time, it can be helpful to consolidate your previous 401(k) funds with your new employer’s. Ultimately, however, it’s worth comparing the fees in your new employer’s 401(k) against your previous employers’, as well as with those of an IRA. Comparing administration and portfolio fees side-by-side will allow you to make the most accurate decision as it relates to fees and expenses for your retirement savings.
- Like all 401(k)’s, your money can continue to grow tax deferred
- All 401(k) accounts can be consolidated into one place
- You may be able to take penalty-free withdrawals if you separate from the new employer in the year you reach age 59 1/2 or later
- You may have access to loans and hardship withdrawals
- You will be subject to the distribution options under the new plan
- Your investment options will be determined by your new employer’s plan
The “Cash out” option
There is—technically—another option, though it’s highly discouraged: You can cash out the funds from your previous 401(k) by distributing the funds directly to you. However, the distribution would be subject to a mandatory 20% federal income tax withholding on any taxable amount. Also, the distribution is subject to a 10% IRS early distribution penalty if you are under 59 ½ and do not qualify for an exception. Not to mention, you could be missing out on tax-deferred growth of your retirement assets.
- You gain immediate access to your money, after taxes and penalties are paid
- You can still roll over eligible amounts without any tax consequences within 60 days of receiving your distribution
- If you were born before 1936, you may be eligible for favorable tax treatment for a lump-sum distribution if you meet certain other requirements.
- Your cash distribution may be subject to multiple taxes, including a 20% federal income tax withholding and additional local, state, and federal income taxes
- If taken before age 59 ½, your withdrawal may be subject to a 10% early distribution penalty
- You may miss out on the potential growth of your retirement assets by distributing them early, instead of letting them grow tax-deferred
Deciding what to do with your retirement savings from a former employer can seem daunting, but it’s worth exploring the options. Management and portfolio fees can have a big impact on your savings—especially over the course of decades—so it’s important to research and find the best solution for you. After all, we work to retire!
The information provided herein is general in nature and is for informational purposes only. It should not be used as a substitute for specific tax and/or financial advice that considers all relevant facts and circumstances. You are advised to consult a qualified financial adviser or tax professional before relying on the information provided herein.