I Changed Jobs. What Happens With My 401(k)?

Today we’ll be diving into a pretty straightforward topic that most, if not all of us, will face: What happens to your 401(k) when you leave an employer? In today’s day and age most folks are switching jobs every few years for better pay, opportunity, or both. Knowing your options is always important!

I’ll start by backing up to your decision to leave. While you’re weighing how to time your decision (hopefully it’s calculated) it’s always a good idea to double-check your 401(k) plan to see if you may be forfeiting any money. Some 401(k)s have vesting periods for employer match funds or for company 401(k) “dumps” (bonus contributions beyond employer match that some employers make on a yearly basis) and it’s important to strategize if you want to keep as much of that money as possible when you leave. Obviously you shouldn’t compromise a better opportunity and/or your happiness too much, but if staying an extra month can secure a nice sum of money it may be worth it!

So now you’ve left and you’re wondering what exactly you can do with your old 401(k). Or you have old 401(k)s floating out there and you’re wondering what to do with them. I’ll lay out the 4 options you have and some of the key advantages/disadvantages of each:

1. Keep it where it’s at. You actually don’t have to move your 401(k) out of your old plan so long as your former employer doesn’t force you to take it out or go out of business, in which case you'd have to take it out. You’ll remain in the investment mix you are in until you decide to make any changes.

• Advantages: You will stay invested in the assets that you already had, which is usually a diversified portfolio of mutual funds at a risk level either you determined or has been determined based on your retirement date. These investment mixes are generally fundamentally sound and will prevent participants from being able to take on excessive risk with their funds. You may also be able to invest more cheaply in a 401(k) as opposed to paying an advisor. This does vary from plan to plan so you should examine your costs to compare with other options.

• Disadvantages: 401(k) plans tend to be highly restrictive in the investments you can choose from. Therefore while your investment mix will mostly align with your risk tolerance you aren’t able to customize it for your situation as much as you could with an IRA. 401(k)s can be relatively illiquid; the process of getting funds out can be very complicated and stressful, especially without the help of a financial professional. You may also be forced out of your plan by your company (or their demise). Speaking from personal experience it once took a client of mine and me six months to get the client’s funds out of his old company’s 401(k). Between the paperwork, signatures/notarization, and the fact that the company forgot to terminate their plan before dissolving, it was extremely difficult to access the funds. That’s a worst-case scenario, but I dealt with enough headaches regarding 401(k) distributions to know that it’s something that shouldn’t be done under pressure or on a deadline. Having your retirement money in many different places can make keeping track of your investment mix difficult. This could lead to potentially taking on too much risk, or not enough, depending on what your financial objectives are. Organization is key and having your retirement assets all over the place could compromise your risk levels and make your funds difficult to monitor.

2. Roll it over to your new employer’s plan. You can move your old 401(k) to your new one with no tax consequences (so long as you are able to get the funds moved out of the old 401(k) and into the new plan within 60 calendar days).

• Advantages: Your employer sponsored retirement funds are going to be in the same place. This helps with the aforementioned organization and monitoring of your portfolio.

• Disadvantages: Flexibility comes back into play. Once your money is in the new plan you are restricted to the investment options offered in the new plan. Accessing the funds in case of an emergency will also be more complicated than if you rolled the funds into an IRA. I’ll explain more in option 3.

3. Roll it over to an Individual Retirement Account. You can open a Rollover IRA at any major financial institution (Schwab, Fidelity, etc.) and invest the funds in that account. The same 60-day rollover rule mentioned above applies to avoid taxation.

• Advantages: Access to potential exceptions to the early withdrawal penalty. Qualified education expenses and qualified first time homebuyers get a break on the penalty for early withdrawals when the funds are in an IRA. It’s always best to check with an accountant regarding eligibility, but these can be major advantages and these exceptions are NOT allowed with 401(k) withdrawals. The limit of the exception for first time homebuyers is $10,000. Other exceptions do exist and apply to both 401(k)s and IRAs. They are usually for more extreme scenarios and can be found at https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions

You can invest into whatever you please with funds that are rolled over into an IRA. Of course, this doesn’t mean you should take on excessive risk, but it does allow you (or your advisor) to invest in a tailored and potentially more cost-efficient manner. More importantly you’ll be able to invest in a way that is MOST appropriate for you as opposed to the cookie-cutter nature of 401(k) investment mixes. You also have much easier access to the funds should anything happen—obviously this would be only in emergency scenarios, but having relatively quick access to the funds could be crucial should something arise. Going back to what I said earlier about 401(k)s being difficult to withdraw from—it’s better to have easy access to funds in the event of an emergency rather than getting caught in a bind.

• Disadvantages: Sometimes having the freedom to make your own investment choices can be your downfall. You are now the master of your funds, and that comes with great responsibility. 401(k)s keep the training wheels on so to speak, and a lot of people benefit from that. If you lose money in an IRA you don’t even get the silver lining of being able to deduct your losses on your taxes. The money is simply gone. So investing appropriately is of crucial importance. You also have to be on top of organization of how much risk you’re taking on if you have a 401(k) and funds in an IRA. You’ll need to make sure that the combined accounts align with your investment objectives. If you work with an advisor they should be able to assist with this, and the management of the investments as well.

4. Cash out the 401(k). I definitely did not save the best for last. This option should really only be used in absolute emergencies as a last resort. If you’re under age 59 ½ you will be hit with a 10% early withdrawal penalty, and the amount of the withdrawal will be added to your taxable income for the year. Taking your funds out will likely lead to a massive tax bill and eliminate the point of ever putting funds in there in the first place. But it is an option in dire circumstances and depending on the nature of it the exceptions I mentioned previously may apply.

Everyone’s situation is different, and the benefits (or disadvantages) of each option may be more pronounced for some than others. Because these matters potentially involve both taxes and investments it’s always a good idea to consult with a tax professional and an advisor to examine your situation and help determine what’s best for you. Your advisor may be able to do both. See our blog regarding finding an ethical advisor if you’re unsure of where to start. You can also send any questions you have to our inbox!