LAST REVIEWED Dec 18 2020 8 MIN READ
By The Human Interest Team
What happens with my 401(k) if I quit my job? Can my employer keep my 401(k)? We hear a lot of questions from people wondering what happens to their retirement savings during a job transition and that’s no surprise — an average person will hold 12 jobs between the ages of 18 and 52.
The money in your 401(k) is yours, though the account is tied to your employer so there are some factors to consider. This guide that outlines your options if you leave a job and how to decide which is best for you.
You have five options:
When you change jobs, we'll walk through what you can do with your 401(k), each in a section below:
Leave It Where It Is (With Your Former Employer)
Roll It Over to Your New Employer
Roll It Over into an IRA
Cash It Out
If You’re at Least 59 ½ Years Old: Take a Distribution
But before you do anything, you’ll need to take stock of a few things that will help determine what your balance is:
Do you have an outstanding balance on a 401(k) loan? For most people, the answer is no, but if you do have an outstanding 401(k) loan, then leaving your job will change your timetable for paying back the loan. Typically, if you and your employer part ways, your loan balance becomes due within 60 days of separation. You will need to figure out a plan to pay that loan back.
Are you fully vested? What you see as your 401(k) account balance may not be your true account balance. Why not? If your employer offers matching contributions, they decide whether to transfer ownership of those funds immediately (this happens with 58% of 401(k)s plans) or after some period of time (commonly referred to as a “vesting schedule”). You can look up the vesting schedule associated with your 401(k) in your plan documents (available in your online account or mailed to you). Note: Any contributions you’ve made yourself are always 100% immediately vested.
Read more about vesting schedules for employer contributions here.
Now that you’ve taken steps to figure out your true balance, let’s review the five options you have for your 401(k).
1. Leave It Where It Is (With Your Former Employer)
Whether you have the choice of leaving your 401(k) with your former employer will depend, in part, on your account balance.
If your 401(k) account balance is under $1,000. If your balance is less than $1,000, your employer can cut you a check. Just be sure to roll those funds over into an IRA rollover in order to avoid early withdrawal penalties.
If your 401(k) account balance is between $1,000 and $5,000. Your employer can move the money into an IRA of the company’s choice. If this is the case, watch out for fees attached to the new IRA - some can be pretty hefty.
If your 401(k) account balance is greater than $5,000 then most plans allow you to leave your assets where they are. If you fall into this category, then you should compare how satisfied you are with your current employer’s 401(k) vs. what your new employer offers. We’ll cover this in the next section.
2. Roll It Over to Your New Employer
This option is only available if your new employer offers a 401(k) as an employee benefit. Check with your new company to learn about their retirement plan options and eligibility criteria for participating in the plan.
70% of employer plans allow employees to contribute as soon as they are hired, although 30% require a waiting period (typically a few months) before employees can start making contributions.
How to choose between your old vs. your new employer’s 401(k):
Compare maintenance and 401(k) transaction fees: Log into your old 401(k) and check your recent transaction history as well as recent statements to see what fees you are being charged. Some 401(k) providers (or employers) charge excessive fees to the accounts of employees that are no longer with the company (aka “terminated employees”). You should also check your plan documents to see what 401(k) transaction fees they charge. For instance, if you were to take a distribution, take out a loan, or go through a divorce, most 401(k) providers will charge you a fee. Human Interest does not. (You can read more about the 401(k) transaction fees we’ve eliminated here.)
Compare investment options (and associated fees): 401(k) plans differ widely in terms of the investments they offer as well as the associated fees. As part of our commitment to clear, affordable pricing, the core investment options offered by Human Interest are intentionally selected to minimize the fees you pay.
Compare advice or educational tools: Some 401(k) providers offer advice or guidance regarding what investments may be best-suited to you given your financial situation, your age, and comfort with risk. In fact, to make it easy, some 401(k) providers may give you the option of choosing a portfolio they set up for you automatically, taking those personalized factors into account. That way, you don’t have to figure out what funds to invest in, how much to choose of each, or worry about whether you’re invested in a way that suits your comfort with risk or retirement goals.
3. Roll It Over to an IRA
If your new employer doesn't offer a retirement plan or if you’re in between jobs, you won’t have the option of rolling your old 401(k) into a new 401(k). An IRA could still be a good option.
With an IRA, you’ll have the opportunity to continue investing in your retirement and you may even have access to more investment options than your 401(k) (if your plan had limited investment options).
One downside relative to your old 401(k) is that you can’t contribute as much to your retirement each year In 2020 and 2021, the contribution limit for an IRA is $6,000 if you’re under age 50; $7,000 if you're 50 or older (note: this is much lower than the annual contribution limit for a 401(k) – $19,500 if you’re under age 50; $26,000 if you’re 50 or older).
Another disadvantage of an IRA is the funds may be more accessible to creditors, so if you are (or could be) in a legal dispute, you may not want to roll over to an IRA and instead keep your current employer 401(k) open. In addition, IRAs don’t offer the option of being able to take out a loan (though you should think twice before borrowing money from your 401(k) anyway).
A final consideration relates to withdrawals. If you leave your employer at age 55 or older in order to retire, you can generally withdraw funds without a 10% early-withdrawal penalty from a 401(k). With an IRA, however, you typically need to be age 59 ½ to make withdrawals avoiding a 10% early withdrawal penalty.
Frequently asked questions
If I roll over a 401(k) to an IRA, does that count toward my annual contribution limit for an IRA?
No, any funds you roll over from a 401(k) to an IRA don’t count towards the $6,000 ($7,000 if age 50+) annual contribution limit. You’ll still be able to put in $6,000 (or $7,000) on top of that.
Can I contribute to a traditional or Roth IRA if I’m covered by a retirement plan at work?
Yes, you can participate in both an IRA and 401(k).
Are contributions to a traditional IRA tax-deductible?
Yes, however, the amount you can deduct may be limited if you (or your spouse) is covered by a 401(k) or another retirement plan at work and if your income exceeds certain levels. Look here for 2020 rules around tax deductions for IRAs:
If either you or your spouse is covered by a retirement plan at work
If neither you nor your spouse is covered by a retirement plan at work
Where can I open an IRA, and how do I choose one?
This might depend on the balance of your account. Some banks or financial institutions have a minimum for opening an account whereas others do not. IRA providers also vary in the guidance they offer on how to choose investments as well as the fees. Some are known for having a complex interface that requires having investment savvy. If that’s not what you’re looking for, be sure to shop around at different banks or brokers.
4. Cash It Out
Most financial advisors caution against cashing out a 401(k) because not only does it reduce your retirement savings, but it also means you’ll miss out on the tax advantages you had from contributing in the first place. In fact, cashing out a 401(k) comes with a hefty penalty because the IRS considers it to be taking an “early” distribution from an account that is supposed to be saved until retirement.
If you cash out your 401(k), you’ll be taxed on the entire amount (it counts as taxable income and comes with a 20% mandatory withholding) AND you’ll have to pay an additional 10% early withdrawal penalty on top. The mandatory withholding (and other penalties) applies even if you plan to roll over the funds later.
If your account balance is below a certain amount (which varies depending on your plan, but is usually $1,000), you may be forced to take the cash. These are also called involuntary cash-outs.
5. If You’re at Least 59 ½ Years Old: Take a Distribution
If you’re nearing retirement, this is another option to consider. Starting at age 59 ½, you become eligible to take distributions from your 401(k). What does that mean? You can start taking some money out without paying the 10% tax penalty for early withdrawal.
If you have a traditional 401(k), you will need to pay income tax on your distributions – ideally, you’ll be in a lower tax bracket now than you were when you made the contributions.
If you have a Roth 401(k), your distribution will be tax-free provided you’ve held the account for at least five years.
Reviewing the five options can take some work, but it’s well worth it – your future self will thank you!
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.