Have you changed jobs or retired and left money behind in your former employer’s 401(k) plan? You worked hard to set aside that money for your future, so you want that money to continue working for you. Understanding your options is essential to making sure you preserve – and continue growing – your retirement savings.
When you leave an employer with savings in a company 401(k) plan, you generally have four options.
1. Cash Out Your Account
You already know that cashing out isn’t typically the best option for your future. Your plan administrator will withhold 20% of the taxable distribution and send it to the IRS as a pre-payment of the income tax you owe on the entire distribution. For example, if you have a $10,000 account balance, your 401(k) plan will send $2,000 to the IRS and you’ll receive $8,000. In addition to paying income tax, you’ll owe an additional 10% tax if you were under age 55 when you left that employer. In this example, that would mean an additional $1,000 you would owe at tax time ($10,000 x 10%). Most importantly, you not only won’t have that money available to you when you need it in retirement, but you’ll miss out on the chance to continue growing your savings for retirement.
2. Leave the Money in the Plan
You may or may not have the option to leave your money where it is. Many plans have a force-out provision for former employees, which allows them to cash out your vested account balance if it’s less than $5,000 ($7,000 beginning in 2024). If your account is over this limit, they can’t force you out. But employers can choose to not pay plan expenses on former employees. You will also be responsible for staying in touch with your former employer and the 401(k) recordkeeper and providing updated addresses, emails, and phone numbers every time your contact information changes. Additionally, your investment options will be limited to the few that your employer allows in the plan, and you won’t be able to add any money to that account.
3. Roll the Money Over to Your New Employer’s Plan
If you have a new employer and you’re eligible to participate in that employer’s 401(k) plan, you may roll over your old 401(k) account to your new employer’s 401(k) plan. But you’ll first want to ensure that your new 401(k) plan accepts rollovers and that the investments, fees, and services in the new plan are better suited to your goals than your old plan or an IRA.
4. Roll the Money Over to an IRA
An IRA is the most popular retirement savings vehicle for many reasons. It is an “Individual Retirement Account,” which means that it is yours, independent of any employer relationship. You make the decisions about where to open your IRA, when to contribute more money to the account, and how to invest your savings. Depending on your choice of IRA custodian, you can access many more types of investments than are typically provided in a 401(k) plan. You can also withdraw money whenever you want and design a retirement income strategy. Distributions will still be subject to income tax (for non-Roth IRAs) and a 10% additional tax if you’re under the age of 59½, but you can waive tax withholding on IRA distributions if you choose.
In addition to having total control over your savings and investments, IRAs can be used to consolidate all your retirement accounts. You can combine your qualified accounts from any of your prior jobs (and future jobs) into one convenient location. Consolidating can make it easier to manage your retirement savings: you receive one account statement for all your retirement assets, you have one set of account access information to remember, and you may be able to reduce your administrative fees.
Benefits of Rolling Over to an IRA
A rollover, when done properly, is a tax-free transaction, ensuring you preserve all your savings for future growth. To ensure you don’t have any unintended tax consequences, request a direct rollover from your former employer’s 401(k) plan to your IRA and provide your IRA custodian’s deposit instructions. Your money will be moved directly from the 401(k) plan to the IRA, so there’s no chance you can spend it and you won’t lose any of your savings to taxes or penalties.
If you take a distribution from the 401(k) plan payable to you instead, you are responsible for depositing the money in an IRA within 60 days. You also must come up with enough money out of pocket to replace the 20% your plan administrator withheld and put that in the IRA within 60 days to avoid any tax consequences. If you can’t come up with this amount to add to your rollover, it will be included in your taxable income for the year and subject to the additional 10% tax – even though you never received it. (You may or may not receive a refund from the IRS when you file your tax return and reconcile your tax withholding with your tax liability for the year.)
Additionally, our Self-Directed IRA Knowledge Center provides more details on common rollover questions such as explaining the differences between direct rollovers and indirect rollovers and how to initiate a rollover with your plan administrator.
Is a Rollover Right for You?
Different IRA custodians provide different services, allow different investments, and have different fees. Be sure to compare the features of each retirement account option to help you identify the best location for your nest egg. For more information on permissible retirement accounts that qualify for rollovers, see our IRA Portability Chart. You may want to seek out a financial advisor to help you evaluate your options.
To overview the steps involved, the projected timeline, and advantages of funding an IRA with a rollover, visit “Fund My Account“. If you have any questions about rollovers or establishing a self-directed IRA, please contact one of our self-directed IRA experts.