What happens to your 401(k) if you quit or switch jobs?
It doesn't matter if you've been fired, a better job came up, you've decided to start your own business, or even transition into more of a caregiver role. As far as your 401(k) is concerned, you'll be relieved to know that your account balance doesn't just disappear, but your options depend on how much you've accumulated from employer contributions as well as your own.
You always get to keep the contributions you've made through paycheck deductions, but your ownership of employer contributions depends on the vesting schedule used. In many cases this is 3-5 years, meaning that you would own 100% of employer contributions to your 401(k) after remaining in your role with your employer for the set time.
Options for managing your 401(k)
It's important to consider your investment options carefully and be wary of any tax implications as you take steps toward achieving your long-term goals. Your 401(k) is a valuable tool in your overall financial planning strategy and you'll want to make smart decisions that will keep your money working for your future. If your 401(k) balance is at least $7,000, there are four main options you can choose from.
Leave It with Your Former Employer
If you want to leave your 401(k) right where it is while you take on a new job, you can still enjoy tax-deferred growth on your money, however, you can't make any additional contributions. If you jump around from job to job, this seemingly straightforward option can get a bit sticky from an administrative perspective and will limit your wealth management and investment options. It's also much easier to lose track of the money if your old employer changes providers.
Roll Over to an Individual Retirement Account (IRA)
Upon parting ways with your old employer, you can opt for a direct rollover of your 401(k) balance into an IRA with a brokerage or provider like PensionBee. There are a few types of IRAs, all of which offer a broader range of investment options and allow you to retain more control over your personal investments than when relying on an employer plan administrator. Plus, you can gauge your investments and make changes based on past performance.
The goal with an IRA is to choose specific investments such as stocks, shares, or mutual funds that will meet your personal finance goals. A traditional IRA, for example, features tax-deductible contributions and your earnings enjoy tax-deferred growth until you decide to withdraw, while in the case of a Roth IRA, your contributions are after-tax but qualified withdrawals can be made tax-free. With a PensionBee IRA rollover, you can invest in various portfolios of Exchange Traded Funds (ETFs) managed by one of the largest investment managers globally.
Transfer to a New Employer’s Plan
Transferring your 401(k) to a new company plan can also be a straightforward process provided that the new plan allows for rollovers. In this scenario, you'd need to request a direct rollover from your old plan and ensure that the funds maintain their tax-deferred status. Consolidation makes things much easier in terms of tracking your investments, and once set up your new employer can begin to make contributions, but there is a caveat. Your investment options are still limited and you could end up paying higher fees as part of your new plan compared to your old plan.
Cash It Out
The tempting option when you quit or switch jobs is to take the lump sum and run, but this could significantly and negatively impact your retirement goals. The Internal Revenue Service (IRS) allows employers to force minimum distributions for balances under $1,000, but you'd be on the hook for paying income tax on the entire amount. You'd also lose out on the potential for tax-deferred growth which would further impact your long-term retirement savings, and if you're under the age of 59.5, you could suffer a 10% early withdrawal penalty, too. This is why cashing out your 401(k) is an option generally reserved for extreme financial hardship when you're out of money and out of alternative options.
What if your 401(k) balance is under $7,000?
If Your Balance is Less than $1,000
If you leave your job with a vested 401(k) balance of less than $1,000, your employer may cash you out automatically with a forced minimum distribution. But as mentioned, the amount would be subject to income tax and potentially penalty fees. This is why it's advisable to roll over your balance into an IRA, even when it's under $1,000, so it can be used as part of your long-term investment and financial planning strategy.
If Your Balance is Between $1,000 and $7,000
If you switch jobs with a vested balance somewhere between $1,000 and $7,000, your old employer may automatically roll over the funds into your new employer's plan or into an IRA. You should make sure to review the new plan's options and associated fees before making a decision, however, as you may decide to either transfer the funds to an IRA yourself or leave them parked in the old plan if the new plan's fees are too high. As with any investment decision, a financial advisor or financial planner can help you make the most informed choices for meeting your retirement and financial goals.
