What happens to your 401(k) when you quit?

If you are planning to quit your job, one of the questions you may be asking yourself is “what happens to my 401(k) when I quit?”. When you quit your job, your 401(k) could be left with your old employer if you choose. Alternatively, they could be rolled over to an IRA if you decide to. Your 401(k) could also be rolled over automatically to an IRA by your employer if it has less than $5000 in balance.  If you have less than $1000 in your 401(k), the 401(k) provider may force a cash out and send you a check with the balance.

A survey by ING Direct USA reported that at least one in every five Americans left $50,000 or more in their old 401(k) accounts because they were unsure of where to transfer their old 401((k) accounts or they do not know how the rollover process works. Your 401(k) money may represent a sizeable share of your liquid net worth, and hence, you should decide on what to do with your retirement savings when you quit your job.

Before You Quit

Before handing over your resignation letter, you should make sure your 401(k) has no pending obligations. If you took a loan on your 401(k), you should pay it fully so that it is not treated as an early withdrawal. If you quit your job without repaying the loan before the due date, you will be required to pay tax on the outstanding loan amount and an early withdrawal penalty. You should also check with your plan administrator for any pending issues regarding your retirement savings.

What To Do When You Quit

Once you leave your job, you can no longer make contributions to your 401(k). However, the money you've contributed into the account is still your money, and you have the power to decide on what to do with it.

Here are the options you have with your 401(k) account when you quit your job:

Do nothing

While you won’t make further contributions to your former employer’s 401(k) plan, you can choose to leave it if your plan has unique benefits or an attractive portfolio allocation. Most employers allow former employees to retain their 401(k) indefinitely if they have $5000 or more in their account. However, if you have less than $5000 in your account, the employer may force a cash-out by sending you a check. You have 60 days within which you must deposit the funds in a new retirement account to avoid paying income taxes on the distribution.

Leaving your money with your former employer should be a short-term strategy as you find a new retirement plan to transfer your funds. If you leave your 401(k) for a long period, you won’t be able to monitor the accounts as closely as they should. Also, the 401(k) account will incur costs such as administration fees, yet you are no longer a participant. For these reasons, most employees chose to rollover their 401(k) to an alternative retirement plan.

Rollover to a new 401k

If your new employer has a 401(k) plan, you can request your plan administrator to transfer your retirement savings directly to the new employer’s 401(k) plan. You can also ask the plan administrator to send you a check so that you can transfer the funds to the new retirement account. You have 60 days from the date of the distribution to deposit the funds to avoid paying income tax and a penalty on early withdrawals.

Before transferring your funds to the new employer, evaluate the plan to know the fees, rules, investment options, if the new employer offers a matching program, and if you will start participating in the plan immediately. You can get information about the new 401(k) from the HR department or the 401(k)’s plan administrator. If the plan does not suit your needs or the fees are too high, you should consider moving your 401(k) funds into an IRA where you have more investment options and the ability to lower fees.

Rollover to an IRA

Instead of leaving your 401(k) unmonitored, you should transfer your 401(k) into an IRA. IRA rollovers are a popular option for employees leaving the workforce or if the new employer does not have a 401(k) plan. You have access to dozens of investment options including stocks, bonds, REITs, mutual funds, etc.

If you have other 401(k) accounts left with former employers, you can consolidate them using an IRA for easier monitoring. IRAs also offer multiple opportunities for withdrawing money penalty-free if you are buying your first home or paying higher education expenses.

When rolling over your 401(k) to an IRA, ask your former employer to transfer the funds to your IRA through a direct rollover. The former employer will either write a check or transfer the funds electronically to your IRA. Alternatively, you can have the check sent to your address, for you to deposit the funds into your new IRA. Your employer will retain 20% of your distribution for tax payment, and you will receive 80% of the distribution. You must come up with the entire distribution and deposit it to your new IRA within a 60-day window.

Take a Lump-sum Distribution

Rather than leave your money in your employer’s 401(k), you can decide to cash-out by taking a lump-sum distribution. However, you should avoid cashing out your 401(k), since you will receive about half your distribution depending on your tax bracket. The distribution will be taxed at your tax bracket rate, plus you will also pay a 10% early withdrawal penalty. By cashing out, you also roll back the gains you have made in building your retirement savings, and you may never catch up.