What Happens to Your 401(k) After You Leave Your Job?

By Indeed Editorial Team

Updated March 31, 2022 | Published December 7, 2020

Updated March 31, 2022

Published December 7, 2020

Many employers offer 401(k)s as a way to help employees save for retirement. When you leave your job, you'll need to decide what to do with your 401(k). Depending on what you do once you leave your job, you have several options. In this article, we describe four options you have when deciding what to do with 401(k) when you leave a job.

What is a 401(k)?

A 401(k) is a type of retirement plan that employers provide for their employees. You contribute to the 401(k) account monthly up to a particular limit. The amount the employees contribute to the 401(k) account is limited to a maximum of $19,500 for the 2020-2021 fiscal year. For employees who are aged 50 and above, they are allowed to invest $6,500 more as "catch-up contributions."

Generally, all 401(k) contributions are profit-sharing plans. For this reason, employer contributions are capped by the 25% deductibility limit. However, salary deferrals are free from this limit. Over the past few decades, the 401(k) retirement plan has gained popularity among employers and employees alike. It is a qualified retirement plan where employees contribute part of their wages and choose whether it should be pre-taxed or taxed upon withdrawal.

An employee can also choose Roth 401(k), where the employer funds the investment account with after-tax money (up to the contribution limit). This plan is ideal for those who are likely to pay more taxes in retirement. No tax will be levied when you withdraw from a Roth 401(k).

What happens to your 401(k) after you leave a Job?

It's becoming increasingly common for professionals to switch jobs several times throughout their working careers, meaning that most people have to decide what to do with 401(k) after leaving the job. When you switch jobs or get laid off, you have to evaluate your options on what do you with your 401(k) account.

After leaving your current job, you have up to 60 days to decide what happens to your retirement savings. Otherwise, your savings will be automatically transferred to another retirement account. In most cases, employers have clear guidelines indicating what you can do with your 401(k).

What to do with your 401(k) after leaving your job

Before you change jobs, it's helpful to know what you can do with your 401(k). Technically, you have four 401(k) options:

Leave your money with your former employer

For some people, the most plausible option is to leave their investment with their former employer. This option allows you to continue making investments with the money even if you are not working with that employer. In most cases, old employers allow you to leave your investment if you have more than $5,000 in your 401(k) retirement savings account. If your account holds less than this amount, your previous employer may decide to cash out your plan and send you a check for the balance.

The advantage of this option is that it allows you to leave your 401(k) with your former employer if they offer good terms. Leaving your retirement account with your previous employer allows you to wait for registration to open with your new employer.

When you leave your 401(k) savings with your former employer, your access to your money can be limited. Some employers can levy huge maintenance fees, implement restrictions on investment choices and prevent access to your savings until you reach retirement age. Unless you're about to retire and you know you won't change jobs often, avoid leaving your 401(k) with your former employer.

Roll over to an IRA

If you cannot find a new employer or your savings are below $5,000, you may want to move your money to an individual retirement account (IRA). This is also an ideal option if your new employer doesn't offer a retirement plan or the terms aren't what you want. Unlike 401(k) accounts, IRAs provide unlimited investment options, like ETFs, bonds, stocks and mutual funds.

An IRA is tax-deferred, meaning that you'll pay your taxes upon withdrawals when you are 59-1/2 years old. Once you reach age 70-1/2, you'll be subjected to the required minimum distributions. If you make any withdrawals before you are age 59-1/2, you'll have to pay a 10% penalty. You can also opt for a Roth IRA where distributions are 100% tax-free. You pay taxes on the amount you put into the account.

You can take advantage of low-cost investment funds in an IRA, saving you thousands of dollars over time. Once you move your money, you manage your IRA account on your own.

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Transfer your 401(k) to your new employer

If you're changing jobs and your new employer offers a 401(k), you don't have to worry about what happens to 401(k) if you leave your job — you can create a new account and transfer your funds to it.

Your new employer 401(k) plan might be flexible and work well with your investment options and financial goals. Also, since it is easier to track your investment accounts when they are in one place, moving your money to your new 401(k) account can be a good option. 401(k)-to-401(k) transfers are seamless and don't include taxes or penalties.

Learn how to transfer your old 401(k) to your new one before you leave your job. If you receive your proceeds from your old employer via check or cash, a mandatory 20% tax is applied to the savings. If you fail to deposit the money to your new retirement account within 60 days, you are subject to penalties and taxes.

Cash out

If you have no other options for your 401(k) you can opt to cash it out. When you cash out, your employer will send your entire balance via check or bank transfer. Cashing out is subject to penalties and a 20% tax rate, which is much higher than average taxes. If you can, consider opening an IRA instead of cashing out.

How to decide which option is best for you

When you're deciding what to do with your 401(k), consider these options:

Take note of existing 401(k) loans

If you took out a loan on your 401(k), it will be considered defaulted, and you will be taxed on the outstanding balance if you decide to cash out.

Consider direct 401(k)-to-401(k) transfers

If you're rolling over, a direct 401(k)-to-401(k) transfers could be ideal since they don't come with additional costs. Rolling over to an IRA means you'll have to manage your investments on your own or hire a financial manager.

Go for IRA companies with broad investment options

Some IRAs offer limited investment opportunities and come at a pretty high cost. Take time when shopping for an account that suits your investment goals.

Consolidate your nest egg

If you know you'll move from one job to another in your career, consolidate your savings in one 401(k) or IRA account for easy management.

Avoid penalties and taxes

You qualify for tax breaks when you save in a 401(k) plan. However, avoid unnecessary penalties and taxes by not withdrawing your money before the age of 59-1/2. Also, avoid a direct check from your employer because 20% will be withheld for income tax.

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