Due to the tight job market and rising wages, many people have changed jobs over the last several years. That means that they probably left a 401(k) behind at their prior job.
You may be one of those people. If so, what are your options to manage that 401(k)? You have several choices, but it’s important to think each option through before making any decisions.
Let’s break down your options.
Leaving It Where It Is
If your balance is $7,000 or more, you can leave the money with your former employer indefinitely, giving you time to decide the best course of action for you. In this case, you’re under no obligation to move your money. This threshold increased to $7,000 in 2024 from the previous level of $5,000, as part of changes to retirement plans due to the SECURE Act 2.0.
If you decide to leave your 401(k) with a former employer, be aware that managing multiple tax-deferred accounts can prove complicated. Keep tabs on both the account and the company. Be sure to continue reading your statements. Watch the company’s performance. Check your beneficiary once a year to be sure it is who you want it to be to inherit the money if you pass away. Be sure to keep your address current.
Deciding to Move It
If you don’t want to keep your old 401(k) invested with your former employer, you can roll it over into your new employer’s plan or an IRA.
In the past, it was difficult to compare the cost an employee paid for investments through one company’s plan with similar offerings in another company’s 401(k) or IRA. But currently, all fees and costs have to be disclosed, which means you can now compare apples to apples.
As you compare the plan costs, ask for the participant fee disclosure for each plan. That document will reveal all the fees—both obvious and obscure—associated with each plan.
Look at both your current investments and your prospective new plan. Evaluate and compare the costs. At this point, you will have a better idea regarding which choice is best for you.
How Much Can You Move?
You are entitled to 100% of any contributions you’ve made into the 401(k) plan, but how much of the employer match are you entitled to? That answer varies based on how the plan is set up and the vesting period.
A vesting schedule is based on the length of time required to have ownership in the employer’s contributions. If you are 100% vested in employer contributions, you will receive all of the money the company has contributed on your behalf.
If you have not been with the company for the required amount of time, you may receive a percentage of employer contributions, based on the plan’s vesting schedule. The rest of the money set aside for you is forfeited back to the company. Most 401(k) providers state how much of your balance is fully vested. If you’re not sure, you can always call to inquire.
Tax Considerations
A 401(k) is funded by pre-tax contributions and is considered a tax shelter, which is why you’ll pay ordinary income taxes on any distributions. How much you’ll pay depends on your tax bracket, as income tax brackets range between 10% and 37%. Significant distributions from your 401(k) can push you into a higher tax bracket, so you’ll pay more in taxes than in a normal year. Withdrawing money from your 401(k) before age 59½ means you’ll pay a 10% penalty on the total amount, in addition to taxes.
An exception is the Rule of 55, an IRS provision that allows employees to withdraw funds from their 401(k) or 403(b) retirement accounts without penalty if they leave their job at age 55 or older. The rule applies to the calendar year in which the employee turns 55, regardless of their actual birthday. The rule only applies to your current employer’s retirement plan, not previous retirement accounts or IRAs.
Rolling It Over Into a New Plan
Check with your new employer to see if they will accept a rollover from your previous employer’s retirement plan. Assuming you like your new plan’s costs, features, and investment choices, this can be a good option.
Most custodians will initiate the paperwork to directly transfer the money from your old account to the new one. Check with your new human resources department to find out when you can start a 401(k) and ask them to outline what’s in the plan documents, such as investment choices and fees. If you don’t like the investment choices or think the fees are too high, you may want to roll over your 401(k) to an IRA, or just invest enough to receive any employer match.
Rolling It Into an IRA
Another option is to roll your 401(k) balance into an IRA. This could be either an existing IRA you previously opened or a new IRA. Because IRAs aren’t sponsored by employers—you own them directly—you won’t have to worry about making changes to your account should you change jobs again in the future. IRA providers may also offer a wider array of investment options and services than either your old or new employer-sponsored plan.
If you choose the IRA path, you should avoid having money sent directly to you. Have the plan sponsor send the money straight to the custodian, the entity where you open the IRA. You should keep track of when you open the IRA and when it gets funded.
Cashing It Out
In the long run, your financial future will be better served by rolling the money over into an IRA or your new employer’s 401(k) plan. Cashing out retirement accounts isn’t the best move. But plenty of people do it anyway.
Withdrawals are subject to mandatory 20% federal withholding and, in some cases, mandatory state withholding. However, if you fail to move the money into a qualified retirement plan within 60 days, it is taxed as ordinary income, plus a 10% penalty if you’re under 59½, which means you could end up paying significantly more than 20%, depending on your federal and state income tax rates. You may also negatively impact your retirement goals.
Conclusion: Time Is On Your Side
Whether you keep your 401(k) where it is or roll it over to your new employer’s plan or to an IRA, the important point is to keep the money set aside in some kind of retirement account.
By keeping it in those specialized retirement accounts, you’ll accumulate more money for retirement. Before deciding on what to do with a 401(k) after leaving a job, consider speaking to a financial adviser or a certified public accountant—or both. These professionals can help you navigate the potential deadlines to meet and understand the significant tax implications.
Whether you have set aside a lot or a little, time can work its magic on all amounts of money. Your future self will thank you for keeping the funds invested for their intended purpose.
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