The Smartest Thing To Do with Your 401(K) When You Leave A Job
Your 401(k) is probably one of the best job benefits, but most people don’t stay at the same company for their entire career. So what happens to your 401(k) if you quit your job? Below we’re going to cover your 401(k) options, including how to handle a 401k loan.
3 Options for What to Do With Your 401k When You Leave Your Job
If you have a 401(k) and leave your job, you have three options to handle this account:
Leave it alone.
Withdraw the money.
Roll it over.
Note: These steps also apply to a 403(b) as these are considered the same type of account as a 401(k) from a tax perspective.
Let’s break down each option for your 401k below.
1. Leave It Alone
You can leave your 401(k) alone with two exceptions.
If your account balance is less than $5,000, they have the right to tell you your money cannot stay in the account and may force it our into an IRA in your name (an involuntary cash out).
If you contributed less that $1000, they may choose to write you a check but will subtract 20% for taxes and a 10% penalty will apply for those under age 59.5.
If these situations don’t apply, then you can leave your account alone. Be sure you’re happy with your current plan’s investment choices, as well as the fees.
Note: Should you choose this option, you won't be able to make new contributions or adjust your current investment choices.
2. Withdraw the Money
You can withdraw your money, but this is not recommended. If you are under the age of 59 ½, you will be charged a 10% penalty on the amount withdrawn. On top of that, it will be considered taxable income and, generally, an automatic withholding of 20% is taken out.
Withdrawing the money from your 401(k) all at once can cost thousands of dollars in penalties and taxes. Instead of withdrawing the money, take the time to set up a proper transfer so you can keep your money working for you.
3. Roll Over Your 401k
Typically, one of your best options is to roll the money from your old 401(k) over into your new 401(k) plan when you are eligible, as it's the safest way to avoid being hit with penalty or income taxes. If you have a new employer, ask your new human resources representative to help you with the forms to start the process. You'll need information on your old account, so make sure you have that handy.
It's also possible to roll your 401(k) into an IRA. This allows you greater control over the investments you include in your account. If you aren't happy with the investing choices presented by your new employer's plan – or even if you just want more flexibility and control – rolling your 401(k) into an IRA can make sense.
If you don't mind paying the required taxes, you can convert your traditional IRA to a Roth IRA for tax-free earnings going forward.
Can You Keep All Your Money? It Depends on Your Vesting Schedule
While your 401(k) funds are yours, if you’re not fully vested, there may be a portion that isn’t really yours. Fully vested means you wholly have rights to all the funds in the accounts.
What you should watch for is your employer matching program and their vesting schedule. The money your employer has contributed on your behalf through a matching program is not always 100% vested. Many plans require that you work for a company for a certain amount of time before the match portion is completely vested. It's common for 401(k) plans to require you to work between two and six years to be fully vested.
An Example of A Vesting Schedule
Let's say your company plan vests 20% of the employer match each year (until you reach 100%) for five years. If your employer contributes $2,000 per year to your 401(k) and you change jobs after three years, you'll only get 60% of those employer contributions (3 years x 20% vesting each year) or just $3,600, rather than the full $6,000 the employer put in.
If you are close to reaching another vesting period, it might be worth it to stick it out a little bit longer if your company has a generous matching program. You could walk away with thousands more. Using the earlier example, if you were to stay in for the "fully vested" five years, you'd get to take 100% of the $10,000 in employer contributions ($2,000 x 5 years).
What Happens if You Have a 401k Loan and Change Jobs?
If you have an outstanding 401(k) loan, the amount will need to be repaid in full before you leave your job. You will not be able to finish out your loan term.
Repay Your 401k Loans
Prior to 2018, the tax law dictated you had 60 days to repay a 401(k) loan when you left a job. However in the Tax Cuts and Jobs Act, you now have the option to offset your account balance with the outstanding balance of the loan during a rollover. This could be to another eligible IRA or retirement account.
This offset distribution uses your current 401(k) funds to pay the amount of the outstanding loan balance without giving you any money. It’s like taking money out of your 401(k) (i.e. because it’s being taxed) and putting it back as outside cash to pay off your loan – all while making a rollover happen.
If a 401(k) plan loan is offset, you have until the due date of your tax return for the year you leave your job to pay the taxes and penalties (including extensions). An offset distribution is reported with code M in box 7 of the Form 1099-R for the year in which the distribution occurs (possibly along with code 1 or 2, depending on your age).
Before you change jobs, double-check your 401(k) loan situation to see if you can afford to repay the loan in order to avoid the penalties. If you can’t repay the 401(k) loan, check to see if your 401(k) account has the funds to go through an offset distribution.
Am I Required to Pay Off My 401k Loan in Full?
Even if you are only two years into a five-year 401(k) loan, you will likely be required to repay what you owe. If you don't repay the amount owed, it will be considered an early withdrawal, and will trigger penalties and taxes. You have until tax day the following year to pay those fees and penalties.
Can You Contribute to Your 401k After Leaving Your Job?
If and when you leave your job, you can no longer contribute to your 401(k). This is because your 401(k) is offered through your employer and the contributions come directly from your paycheck.
How Long Do You Have to Roll Over Your 401k?
As previously outlined, if your account balance is greater than $5,000 you could in theory leave your money in a previous employer’s retirement plan indefinitely.
However, should you choose to move the money out there are two distinct ways to do so, either via what is called a direct rollover (recommended) or indirect. Direct rollovers must go directly into the new retirement plan or IRA, and cannot be deposited into a personal account for use. Indirect rollovers however are treated as a distribution essentially unless you deposit them into an appropriate retirement account. You have 60 days to rollover your 401(k) (indirectly) into an IRA, new 401(k), or other eligible retirement account. You can find out more about the 60-day rollover rule on the IRS website.
Where Can I Find the 401k Loan Rules?
The IRS has a comprehensive list of 401(k) rules for you to reference. A 401(k) is offered through your employer, but contribution limits and taxes are set at the federal level. It’s also worth noting that your 401(k) itself is not an investment, but an investment account that houses your investments (i.e. mutual funds and ETFs, which are composed of stocks and/or bonds).
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