What to do with your 401(k) during a job change

What happens with my 401(k) if I quit my job? Can my employer keep my 401(k)? We hear questions from savers wondering what happens to their retirement savings during a job transition. That’s no surprise — the average person holds up to 12 jobs between the ages of 18 and 52. 

Ultimately, the money in your 401(k) is yours, though the account is tied to your employer—so there are some factors to consider. When you change jobs, there are four things you can do with your 401(k), each of which has a section below.

• Leave your 401(k) where it is (with your former employer)

• Roll your 401(k) over to your new employer

• Roll your 401(k) over to an IRA

• Cash out your 401(k)

Below, we’ll walk you through your options and how to decide which is best for you. 

First, ask yourself the right questions

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 upon termination. You will need to figure out a plan to pay that loan back in full, or the loan (and any accrued interest) will be considered income to you in the year of default. 

• 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 makes contributions to your account, they decide whether to transfer ownership of those funds immediately 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), as well as how to determine your vesting calculation, in your Summary Plan Description (available in your participant dashboard). 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 four options you have for your 401(k).

1. Leave your 401(k) 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 vested account balance. 

• If your vested account balance is under $1,000, your employer can cut you a check, less applicable federal and state withholdings. In addition, if you are under age 59 ½, you may be subject to a 10% early withdrawal penalty on the gross amount. If this happens and you want to avoid the taxable event, you can perform an indirect rollover to an IRA within 60 days of the distribution date. 

• If your vestedaccount balance is between $1,000 and $7,000, 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. 

• If your vested account balance is greater than $7,000, you can 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 your 401(k) over to your new employer

This option is only available if your new employer offers a 401(k) as an employee benefit and you meet the requirements to roll in other accounts. Check with your new company to learn about their retirement plan options and eligibility criteria. 

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 and your most recent fee disclosure to see what fees you are subject to. Some 401(k) providers  pass on fees to the accounts of employees who are no longer with the company. You should also check to see what 401(k) transaction fees they charge. For instance, if you were to take a distribution, take out a loan, or request a QDRO (common in divorce situations), most 401(k) providers will charge you a fee. (You can read more about the 401(k) transaction fees that Human Interest eliminated here.)

• Compare investment options available (and associated fees): 401(k) plans differ widely in terms of the investments they offer and the associated fees (if any). Work with a financial advisor to compare the offerings of both 401(k) plans to determine which investments work better for your investment risk tolerance 

• 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 allocate to each, or worry about whether you’re invested in a way that suits your comfort with risk or retirement goals.

3. Roll your 401(k) 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 does not offer a self-directed brokerage option).

One downside relative to your old 401(k) is that you can’t contribute as much to your retirement each year, the contribution limit for an IRA is $7,000 if you're under age 50; $8,000 if you're 50 or older (note: this is much lower than the annual contribution limit for a 401(k) – $23,500 if you're under age 50; $31,000 if you're 50 or older, with a special catch-up limit of $34,750 for those aged 60-63). 

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.

IRA FAQs

If I roll over a 401(k) to an IRA, does that count toward my IRA's annual contribution limit?

• No, any funds you roll over from a 401(k) to an IRA don't count towards the $7,000 ($8,000 if age 50+) annual contribution limit. You'll still be able to put in $7,000 (or $8,000) 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 a traditional IRA and a 401(k), but you may have limits on the IRA contributions you can deduct (See next question for additional information). Roth IRAs have Adjusted Gross Income maximums tied to contribution eligibility.  For more information, please visit the IRS website and/or consult a financial advisor. 

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.

• 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 investment savvy. If that’s not what you’re looking for, be sure to shop around at different banks or brokers. 

4. Cash out your 401(k)

Many financial advisors may caution against cashing out a 401(k). 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. Cashing out a 401(k) may come 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 federal withholding plus applicable state withholding) AND you may be subject to an additional 10% early withdrawal penalty on top. The mandatory withholding (and other penalties) apply even if you plan to roll over the funds later. 

If you’re nearing retirement, consider the cash out option. Starting at age 59 ½, you are no longer penalized for withdrawals from your 401(k). 

• 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 and are over age 59 1/2.

Reviewing the four options can take some work, but it’s well worth it – your future self will thank you!