For many, leaving a job has its uncertainties when it comes to finances. Regardless of how you left, you’ll typically need to complete administrative tasks to ensure the transition goes smoothly.
One of the questions you may ask is: what will happen with your 401(k)? You’ve spent some time setting up your retirement contributions and hopefully received a match from your company; and now that you’re leaving your job, where will all your savings go? Look no further because we’re going to lay out the scenarios so you can ensure your 401(k) assets are secure and you can continue to invest in them.
Keep Your 401(k) Where It Is
If your 401(k) plan has more than $7,000 in assets, most plans allow you to leave the account where it is when you leave. If your current 401(k) has a good line-up of funds and low expenses, this can be a good choice.
However, it’s pretty common for departing employees to move their 401(k) monies, or perform a ‘rollover,’ into another retirement account such as an IRA (individual retirement account) or the 401(k) of a new employer if they have another job lined up.
What is a 401(k) Rollover?
A 401(k) rollover allows you to transfer your 401(k) funds from one retirement account into another and avoid any taxes and tax penalties. This could be from one employer-sponsored 401(k) into another, or into an IRA.
Beware, if you were to distribute your old 401(k) into a retail account (non-qualifying retirement account), taxes would apply and if you are under 59½ years of age, a 10% penalty, too.
Why Rollover Your Funds into Another Account?
One retirement account is easier to track than having multiple accounts. Not only can you keep an eye on your retirement assets under one provider, but you are able to manage your asset allocation in one place, making it easier to adjust your investments and see your rate of return. You’ll also want to consider if the investment expenses are the same or lower and whether the provider offers more of the funds you need or prefer.
Rollover Your 401(k) Into a New 401(k)
If you have a new job lined up, check if it offers a 401(k) plan, if you prefer the investments it offers, and whether it accepts 401(k) rollovers. Typically, you can elect for a direct transfer of your funds from one 401(k) fund into another.
Make sure to take advantage of your new company’s 401(k) by checking to see if the company offers 401(k) matching so you can set your contribution amount accordingly.
What are RMDs?
RMDs stand for required minimum distributions. Once you reach age 73 (for those born between 1951 and 1959) or 75 (for those born after 1960), you will be required to take annual distributions, or withdrawals, from your 401(k) plan for your tax deferred savings (Roth monies are the exception and are not subject to RMDs). The amount you take each year is determined by your expected lifespan and your account balance.
401(k)s Allow You to Postpone RMDs if You Are Employed
If your funds are in a 401(k) and you are still working, you can postpone the required distributions until you retire, which could be well past the age of 73. That means that if you are starting a new job, it may be best for you to roll the old 401(k) monies into your 401(k) account with your new employer.
Your 401(k) Assets are Protected from Creditors and Bankruptcy
Whether you choose to keep your 401(k) assets in your previous account, or roll them into a new 401(k) account, these monies are are typically protected from creditors and bankruptcy. Under the Employment Retirement Income Security Act of 1974 (ERISA), the funds in your 401(k) only legally belong to you once you withdraw them to use as income.
Until then, your 401(k) money is legally in the trust and safekeeping of your employer who is allowed to release it to you upon your termination or retirement. As a result, the IRS is unlikely to be able to force these funds out of your account, but that can change once you take distributions. However, in a divorce, there is a process to transfer assets to the other spouse or vice versa.
Rollover Your 401(k) Into an IRA
If you don’t immediately have a new job lined up or your new employer doesn’t offer 401(k) benefits, you can roll your 401(k) funds into an IRA. IRAs are good options because they typically have low to no administrative fees that some 401(k)s may charge employees, and they can offer a wider variety of investment options.
Rollover into a Traditional IRA vs a Roth IRA
If you decide to rollover into an IRA, you have the option to move your tax deferred 401(k) funds into a traditional IRA and any after tax Roth money into a Roth IRA. Roth 401(k) assets can only be rolled into a Roth IRA. You have already paid the taxes on these monies, and it will remain that way in the new Roth IRA account, so withdrawals are tax-free in retirement.
401(k) funds in a traditional account can also be converted to a Roth IRA account, but there are taxes to consider. Moving your funds from a traditional 401(k) to a traditional IRA can be a good option as you can preserve the tax-deferred status of your retirement assets without paying current taxes or potential withdrawal penalties. If you go the Roth IRA route with tax-deferred money, you will need to pay taxes on the funds you rollover which can be significant. It is a good idea to talk with a tax and financial advisor to ensure you make the right move for your situation.
60-Day Rollover Rule
Regardless of the direction you go, any assets withdrawn from your 401(k) must be transferred into a qualified account, such as a 401(k) or IRA, before the 60-day mark. This rule also applied to monies deposited into a non-qualified account. If the assets are not transferred within 60 days, the money will be taxable, and you could face an additional 10% early withdrawal penalty if you are under the age of 59½.
Remember, you can also choose to keep your 401(k) assets with your previous employer as long as the employer allows without fear of penalties. Once you do decide to move the money, the 60-day rule will come into effect.
Start Taking Distributions After Age 59½
If you are age 59½ or older, and you’re thinking about retiring soon, you can begin to take distributions from your 401(k) if your plan allows it (many don’t) without suffering the 10% tax penalty for early withdrawal. If allowed, any withdrawals made from a traditional 401(k) will be taxed at your ordinary tax rate at the time of withdrawal. If you have a designated Roth 401(k) that is greater than 5 years old, the withdrawals taken at age 59½ or greater are made tax-free, since you have already paid the taxes when you made the contribution.
Cash Out Your 401(k)
Finally, your last option is to simply cashout your 401(k) and take a lump-sum distribution. However, most financial experts would advise against this option, as you will be taxed on the entire amount, and may have to pay early withdrawal penalties if you are under the age of 59½. Not only that, but it would also be more difficult for you to reinvest that money into an IRA or other retirement account, as those have annual contribution limits.
Conclusion
You have spent time and effort building the savings in your 401(k). Leaving a job may be a little scary, but you don’t have to be afraid of what is going to happen to your investments if you take the time to do some research and determine if and when to move your 401(k) money. Whether you decide to move it to a new 401(k), an IRA, or keep it put for the time being, you can still invest in your nest egg wisely. If you’re reaching the age of retirement, you can take penalty-free distributions at age 59½ and begin using your retirement money for your own devices. Whatever path you take, don’t leave your 401(k) behind. You deserve to use your money for a financially secure future.
Key Takeaways:
- If you leave your job, you can check with your former employer to determine if you can keep the assets in your 401(k) account if they total $7,000 or more.
- You may want to rollover your old 401(k) funds into the 401(k) sponsored by your new employer.
- You do not have to take required minimum distributions (RMDs) on 401(k) assets that are in a 401(k) sponsored by a current employer. If you leave a job and are 73 years of age or greater, you will need to take RMDs from your former employer's 401(k) account unless you roll the money into your new employer’s 401(k).
- You can rollover your 401(k) into an IRA, and you can choose to put your monies in a traditional (pre-tax) or Roth (post-tax) account. Roth 401(k) funds must rollover into a Roth IRA, but traditional 401(k) funds can rollover into a traditional or Roth IRA account. A traditional IRA will keep the pre-tax advantages. If you convert tax-deferred savings to Roth IRA, you will need to pay taxes on these funds. This is good to discuss with your financial and tax advisors before doing so.
- If you withdraw your 401(k) assets, you have 60 days to rollover these monies into a qualified retirement account, such as a new 401(k) or IRA. If you fail to do so, you could be subject to withdrawal penalties. You can keep your assets in the 401(k) of your previous employer for as long as the employer allows.
- You can take distributions from your 401(k) starting at age 59½ with no early withdrawal penalties assuming your employer’s plan allows. Distributions taken from traditional 401(k) accounts will still be subject to taxation at this time, while assets taken from Roth accounts will not.
- You can take a lump-sum distribution and “cash-out” your old 401(k), but in doing so you will have to pay income taxes on the withdrawal as well as potential early withdrawal penalties if you are not over the age of 59 ½. It may also be more difficult to reinvest your money in a retirement account in the future due to lower IRA contribution limits than a 401(k).