A 401(k) is a retirement savings plan provided by employees, involving a monthly contribution from the employee.
There is, however, a limit to the amount an employee can contribute to the 401(k) account.
With a 401(k) plan, employees save a part of their earnings. That savings, which is not taxed until disbursed, goes directly into their retirement savings plan, most often sponsored by their employers.
Switching jobs is now a common feature with many workers due to several factors. Others get laid off for many reasons. Once an employer leaves a job, what to do with the 401(k) becomes an issue for evaluation.
Although employers have different guidelines, an employee generally has to decide in 60 days about what to do with the retirement savings after leaving a job. If not, the savings are automatically transferred elsewhere.
You can begin taking qualified distributions from any 401(k), old or new, after age 59½. Before then, any withdrawal attracts a 10% tax as penalty.
Your Options: Three Main Choices
There are three main options in what you could do with your 401(k) when you leave a job.
The first and easiest is to leave it where it is.
The second option is to roll it over into an account provided by your new employer.
The third option is to roll it over into an IRA.
There’s a fourth option of cashing it out outrightly.
Unless you work with one employer throughout your service years, you would one day contemplate what would happen to your retirement savings when you leave a job.
There are only three major options. And they all come with their peculiarities. Before we look into the details of the options, let’s look at some considerations if you are changing jobs and want to decide on your 401(k).
Considerations before Deciding on Your 401(K)
Borrowing from your 401(k) may affect your savings if you do not pay back in the allotted time.
If you’re leaving employment before payment of the loan, and you’re moving into an IRA, you can repay the loan to that IRA before the due date, which is always your tax return deadline of the following year.
You should also note that if you lost a job and are still on the hunt for a new one, your 401(k) is the least of your worries. You can safely leave it in your former employment temporarily while looking for another job. When you get another job, you can then study their retirement plans and decide on whether to move your former savings into your new employer’s plan or not.
When moving from one employment to another, it is important to make a due comparison of the retirement savings plans. This gives you a better option of making the right choices between keeping your funds with your former employer, rolling it over into an IRA or your new employer.
If your choice is to leave your retirement savings with a previous employer, you should do well to monitor the funds and the company. You do this by ensuring you are up to date with the statements of accounts and the company’s financial health. This information is necessary to help you know when to move your money if the need arises.
If you decide to move your savings into a new employer’s savings plan, and you have already started contributing to it, the new employer would seamlessly carry out the rollover.
If you choose an IRA, the advisor will help you make the transition promptly.
The Available Options for Your 401(K)
Let’s consider the primary options available. As said earlier, there are three broad options for your 401(k) when you leave a job.
The fourth option of cashing out is not seen as a wise alternative. If you choose to cash out, your employer will send you your savings.
However, cashing out will subject the savings to stiff financial penalties.
The three options are:
Leaving your money with a former employer
This option is a straightforward choice for employees who leave a job close to their retirement age or are not seriously considering another job.
It allows a former employee to continue managing retirement savings of former workers, although most employers only allow this if the former employee has up to $5,000 in their retirement account. The employer may cash out for those with less than that amount and send it to the person..
This is a straightforward option, and many people find it very convenient as it allows you to keep investing the money even though you are no longer in the firm’s employment.
It also allows you to compare the plans of your new employer if you’ve got a new job. However, former employers often impose maintenance fees on the account, a practice that may cancel out any financial incentives.
If you choose to keep your 401(k) with a former employer, this may limit how you access your savings. This option is only viable for those not aggressively hunting for a new job or is close to retirement age.
If you’re interested in getting a new job soon or are already in new employment, leaving your 401(k) with a former employer may be a bad idea in the long run.
Transfer to a new employer
This option allows you to transfer your funds from your former account to that of a new employer. For the benefit of consolidation, this option is ideal. It enables you to ensure your funds are managed from one place. You create a new account and transfer your savings to it.
However, one needs to be sure that the new employer offers a 401(k) and that one have put in the required qualifying service time.
Once you are qualified and have enrolled in the new plan, the procedure involves electing an administrator who would handle the paperwork of a direct transfer from one custodian to another, and help deposit your funds into the new account. The most significant advantage is that you are saved the risk of owing taxes from oversight.
Another option is to cash out the balance of your previous savings and pay in the funds into your new 401(k) as soon as it is active. However, you have to be sure to make the payment within 60 days of the liquidation.
Another point to note is that for those close to the retirement age, your current employer’s 401(k) savings are not subject to required minimum distributions.
Rollover to an IRA
Sometimes, your new employer doesn’t offer a great plan, and the old employer’s charges are too much to allow you to keep your savings there. You have an option. You can roll your old 401(k) into an IRA. An IRA is an individual retirement account.
In this case, you open the account, and operate it with a financial institution that you prefer.
An IRA offers excellent opportunities because it removes the limitations that employer’s plans provide. It also gives freedom to use your funds for investments, although the IRS doesn’t encourage this. Some kinds of investments are prohibited in the IRA.
If you decide to roll over your 401(k) into an IRA that your new employer does not sponsor, your IRA advisor has to help you through the process to ensure the money gets to the proper destination promptly.
With IRA, you can take charge of your finances and make better plans for your retirement savings. Your advisor can also make a lot of input into ensuring that the savings grow to support a restful retirement.
How to Choose
Choosing what you do with your 401(k) is dependent on many factors.
How quickly you get another job, how many years of service you have left, and how much advice you get from the professionals. Every plan has its advantages and disadvantages. But the overall goal is to have enough savings to support you when retired.
While an IRA is very poor, there are fears that it is not under as many regulatory requirements as employer-funded plans. Yet many see IRAs as the pathways to greater profit.
Making a choice is down to personal preferences most of the time.
Switching jobs is not unusual. What to do with your 401(k), now portable than ever, is critical to sustaining the progress made over the years.
While the help of professionals is essential, be sure to know the pros and cons of every plan before subscribing.
John E Chambers is an experienced financial advice expert. Born in Chicago, he has a master's in Industrial Finance, but he has spent decades offering investment advice to businesses and individuals alike. He is the founder of RetireeWorkforce.com and wants the website to be valuable for retirement advice. In addition, he writes articles that help users jump-start their retirement plans and choose the best investment options. If not pondering over stock market statistics or reading some magazines, you can find John spending time with his family. As an early retiree, John also offers unique insights into what post-retirement life is like.