401(k) Rollovers

What To Do With Your 401(k) When You Leave Your Job

About 44.5 million Americans quit their jobs last year, which is about 28% of all workers in the country. No matter whether you leave your place of work voluntarily or involuntarily, finding a new job is often a stressful process. Not only does leaving a job mean you have to find a new one, but you also need to figure out what to do with the retirement plan from your previous job. In many cases, it may make sense to rollover or transfer your old 401(k) to your new plan - but that is actually the least popular option amongst Americans switching jobs.

A study conducted several years ago found that just under 25% of job switchers with a 401(k) move the money to a new plan. 34% of workers kept the money where it was, and 41% cashed out their old 401(k). If you are part of the nearly ⅓ of all workers that could be leaving their job this year, what should you do with your old 401(k)?

Should you cash out your old 401(k)?

The most popular option taken by job switchers was to cash out their 401(k). In most situations, this is not a smart idea. Funds withdrawn early from a 401(k) will be subject to income taxes and a 10% penalty. In addition to the taxes you will owe, you are also robbing yourself of future compounding growth. Due to the taxes, penalties, and loss of future growth that comes along with taking money out early, it rarely makes sense, even if you are withdrawing money for a “good” purpose, like paying off debt.

Should I leave my 401(k) where it is?

The next most popular option amongst Americans with an old 401(k) is to just leave it where it is. This may sound like the lazy, not ideal option, but in many cases it makes a lot of sense to just leave your 401(k) where it is. It is worth noting that leaving your 401(k) where it is may not be an option if your balance is under a certain threshold. Employers can cash out your 401(k) and send you a check if your balance is under $1,000, and they can rollover your balance to an IRA if your account has less than $7,000. If you have $7,000 or more, though, you can choose to leave your balance in your previous employer’s 401(k) plan indefinitely.

401(k) loans work differently when you leave the company. New loans are generally not available if you are no longer with the employer, and the terms of existing loans may change and you could be required to repay your loan in full within a certain period of time.

If you had a great 401(k) plan with lots of low-cost investment options, leaving it where it is may be a great idea. Don’t try to fix what isn’t broken and move your money to a plan with worse investment options and higher fees and expenses. If you don’t have a new 401(k) or workplace retirement plan to roll the money over to, your only other option may be to roll the money into an IRA. This could make sense, but there are some important differences between 401(k)s and IRAs you need to be aware of before deciding.

401(k)s come with ERISA protections, which may protect your 401(k) balance if you declare bankruptcy or get sued. Depending on the state you live in, IRAs may not have the same protections that 401(k)s do. If you are a higher income individual that uses the backdoor Roth conversion strategy, opening a pre-tax IRA to rollover 401(k) funds could complicate the strategy or make it impossible for you to do.

Should you rollover or transfer your 401(k) to a new plan?

While transferring or rolling your old 401(k) over is the least popular option amongst those that leave their jobs, it may be the best option available if your new plan is better than your old one. Some employers have a waiting period before you are eligible for their 401(k) plan, so you may not be able to transfer immediately after starting a new job, even if your new plan is better. Generally if you are moving money from one like account to another like account (for example, a 401(k) to a 401(k)), this movement is called a transfer. If you are moving money from one account to a different type of account, such as a 401(k) to an IRA, this is generally called a rollover.

No matter if you are rolling your 401(k) into an IRA or transferring your funds from your old 401(k) to a new one, it is better to do a direct rollover or a direct transfer. Direct rollovers or transfers mean the money is transferred directly from one custodian to the next without ever being sent to you. This is not only considered safer since the money is going from trustee to trustee, but taxes are not withheld for direct transfers or rollovers like they are for indirect transfers or rollovers. With indirect transfers or rollovers, the funds are first sent to you, and then you are responsible for sending them along to your new custodian. Taxes are withheld from indirect transfers or rollovers in case you don’t contribute the money to your new account within the allowed time (typically 60 days).

How long do you have to move your 401(k) after leaving a job?

If you have $7,000 or more in your old 401(k), there’s no time limit on moving your old 401(k) to your new one after leaving your job. You can decide to leave it there forever, transfer it to the new plan as soon as you are eligible, or even wait a few months or a few years before rolling it over. If you initiate an indirect transfer or rollover, though, the timer starts ticking and you have 60 days to get the funds in the new plan. You should always choose to do a direct rollover or direct transfer when rolling funds over to your new plan.

Deciding what to do with your old 401(k) is just another stressful decision you have to make after leaving a job. Cashing your 401(k) out is almost certainly not the right decision, but depending on your old plan, it could make sense to roll it over or leave it where it is. Not sure what to do with your old 401(k)? Feel free to get in touch and learn more about working with Aberdour Investments.