What To Do With Your 401 When You Quit Your Job
One of the commonly overlooked aspects of changing jobs is deciding what to do with your 401 tied to your previous employer when you leave. Its understandablewhen youre bursting with all the energy and excitement that comes with tackling new challenges at a new job, figuring out what to do with your old 401 will probably be the last thing on your mind.
But that doesnt mean its not important. What you decide to do with your old 401 when you leave your job can potentially net you thousands of dollars in avoided fees and stronger investment returns over the long term depending on which path you ultimately decide to take. And when were talking about that kind of money, it pays to understand what your options are and the consequences of each.
In this article, were going to dive deep into the four primary options you have at your disposal when you decide to leave your company for whatever reasoneither voluntarily or involuntarily . By the end of it, you should have a solid understanding of the pros and cons of each and a pretty clear idea of which direction you should take based on your own unique financial situation.
I do need to point out that before making any significant financial decisions, you should consult a professional who can guide you through the process and help you better understand the implications of your decisions.
Your Retirement Money Is Safe From Creditors
Did you know that money saved in a retirement account is safe from creditors? If you are sued by debt collectors or declare bankruptcy, your 401k and IRAs cannot be liquidated by creditors to satisfy bills you owe. If youre having problems managing your debt, its better to seek alternatives other than an early withdrawal, which will also come with a high penalty.
What Happens To Your 401 When You Leave
Since your 401 is tied to your employer, when you quit your job, you wont be able to contribute to it anymore. But the money already in the account is still yours, and it can usually just stay put in that account for as long as you want with a couple of exceptions.
First, if you contributed less than $5,000 to your 401 while you were with that employer, theyre legally allowed to tell you, Your money doesnt have to go home, but you cant keep it here. . If you contributed less than $1,000, they might just mail you a check for that amount in which case you should deposit it into another retirement account ASAP so that you dont get hit with a penalty from the IRS . If you contributed between $1,000 and $5,000, your employer might move your money into an IRA, which is called an involuntary cashout.
Also, if you had a 401 match, then you only get to keep all of that money if the contributions had fully vested before you left. If not, your employer would get to take back any unvested contributions.
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Scenario : Lump Sum Distribution
If you choose a lump sum distribution, the brokerage will withhold 30% from the proceeds if you are a non-resident alien. You may be eligible for a reduced rate if there is a treaty with your home country. Canadians, for instance, are only subject to a 15% withholding tax.
The tax withheld from your 401 proceeds will be applied to your actual tax due in the US. The tax you owe to the IRS may be more or less than the amount withheld. If your actual tax due is greater than the amount withheld, you have to pay the balance. If the amount withheld is more than your tax due, you have to file Form 1040-NR to claim a refund if you are no longer a US tax resident. As far as the US is concerned, once you have moved to your home country, you will only pay US taxes on US-Situs assets if you are a non-resident. Thus, if distributions are small, you could fall into the lowest US bracket and essentially pay 0%.
If your home country requires you to declare and pay taxes on worldwide income, you will have to declare the lump sum distribution as part of your gross Income in your home country, less any credits or exemptions. If there is a tax treaty between your country and the US, you may be eligible to claim actual tax payments in the US as a tax credit in your home country. An experienced tax advisor like MYRA can help you determine the taxes you can expect to owe in retirement.
You Can Roll Your Old Plan Into Your New Employer’s Plan
If you don’t want to keep your money in your previous employer’s plan, you can choose to roll over your 401 account to your new employer’s plan.
Check with the administrator of your new plan to find out if you can roll it over right away, or if you have to wait until you’re eligible to participate in the plan to do so.
This option lets you keep all of your 401 money together in one account.
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How To Cash Out A 401 After Quitting
You may follow this type of action plan for your 401 when you quit your job:
If your new employer offers a 401 plan, check your eligibility and enroll yourself.
Once enrolled, get the funds and investments in your old account directly transferred to your new account. You can opt for a direct administrator-to-administrator transfer through simple documentation to avoid potential taxes and penalties.
Instead of direct transfer, you can also cash out your old account and deposit the proceeds in your new account within 60 days of cashing out. That way, you dont have to pay income tax on the amount of the withdrawal .
You must start taking 401 distributions after you turn 70 ½ years old and you are not working anymore. However, unlike traditional plans, in a new retirement plan with your current employer, you cannot be forced to take the required minimum distributions even after you reach the age of 70 ½.
If your new employer does not have a 401 plan or you do not like the plan your new employer has, you may roll over your old 401 account to an IRA. The rollover process is like the process of rolling over to a new account. You can either get it done directly through your plan administrator or take out the proceedings and deposit them in your IRA within 60 days.
Will You Owe Taxes Probably Yes
You will pay income taxes at your current tax rate on distributions from your 401. Plus, if you are under the age of 59½, your distribution will be considered premature, and youll lose 10% of it to an early withdrawal penalty.
If you have an outstanding loan from your 401, you will have to repay it within a certain time frame, or the amount will be treated as a distribution for tax purposes.
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Things To Know About Your 401k Before Leaving A Job
Modified date: Jul. 11, 2021
Editor’s note –
Think about the last time you received a job offer. Did you compare the pros and cons of accepting the new position? Perhaps you evaluated the differences in compensation, vacation time, and the cost of health care. Did you remember to include the cost of benefits you were leaving behind?
I didntuntil I made a costly 401 mistake.
I left my job on a Wednesday afternoon, after three years and 364 days in that position. If I had just worked through Thursday and hit 4 years of service a mere 24 hours later my 401 would have been fully vested. I left nearly $3,000 on the table!
When I realized my mistake, months after the fact, it was far too late to make a correction. However, you can avoid making the same mistake and other silly blunders. All you need to do is arm yourself with the facts needed to make an informed decision.
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Here are five steps you should take before leaving a job with a 401:
Our Take: When Can You Withdraw From Your 401k Or Ira Penalty
There are a number of ways you can withdraw from your 401k or IRA penalty-free. Still, we recommend not touching your retirement savings until you are actually retired. Compounding is a huge help when it comes to maximizing your retirement savings and extending the life of your portfolio. You lose out on that when you take early distributions. To see how much compounding can affect your 401k account balance, check out our article on the average 401k balance by age.
We understand that its always possible for unforeseen circumstances to arise before you reach retirement. Being aware of the exceptions allows you to make informed decisions and possibly avoid paying extra fees and taxes.
To take control of your finances, a good place to start is by stepping back, getting organized, and looking at your money holistically. Personal Capitals free financial dashboard will allow you to:
The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.
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Dont Roll Over Employer Stock
There is one big exception to all of this. If you hold your company stock in your 401, it may make sense notto roll over this portion of the account. The reason is net unrealized appreciation , which is the difference between the value of the stock when it went into your account and its value when you take the distribution.
Youre only taxed on the NUA when you take a distribution of the stock and opt notto defer the NUA. By paying tax on the NUA now, it becomes your tax basis in the stock, so when you sell it , your taxable gain is the increase over this amount.
Any increase in value over the NUA becomes a capital gain. You can even sell the stock immediately and get capital gains treatment. The usual more-than-one-year holding period requirement for capital gain treatment does not apply if you dont defer tax on the NUA when the stock is distributed to you.
In contrast, if you roll over the stock to a traditional IRA, you wont pay tax on the NUA now, but all of the stocks value to date, plus appreciation, will be treated as ordinary income when distributions are taken.
Direct Vs Indirect Rollovers
A direct rollover is when your money is transferred electronically from one account to another, or the plan administrator may cut you a check made out to your account, which you deposit. The direct rollover is the best approach.
In an indirect rollover, the funds come to you to re-deposit. If you take the money in cash instead of transferring it directly to the new account, you have only 60 days to deposit the funds into a new plan. If you miss the deadline, you will be subject to withholding taxes and penalties. Some people do an indirect rollover if they want to take a 60-day loan from their retirement account.
Because of this deadline, direct rollovers are strongly recommended. In many cases, you can shift assets directly from one custodian to another, without selling anything. This is known as a trustee-to-trustee or in-kind transfer.
Otherwise, the IRS makes your previous employer withhold 20% of your funds if you receive a check made out to you. It’s important to note that if you have the check made out directly to you, taxes will be withheld, and you’ll need to come up with other funds to roll over the full amount of your distribution within 60 days.
To learn more about the safest ways to do IRA rollovers and transfers, download IRS publications 575 and 590-A and 590-B.
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What Happens To 401k If You Leave
There are a few things that might happen to your 401 k when you quit. A lot of this depends on your employer and the type of retirement account you have. When you leave a job, your old employer may choose to roll the money into another account. However, the money generally stays in your retirement account. You can’t put more money into the account once you’ve left your old employer, but the funds should be able to stay there untouched.
Cashing Out Your 401 After Leaving A Job
Based on the amount of money in your 401 account, your employer may allow you to leave the account with them. However, you will not be able to contribute any more to your old account.
Leaving your account with the old employer may not be prudentespecially when you have access to more flexible Individual Retirement Account plans from most brokers. You may roll over your 401 account to your new employer or transfer the funds into an IRA. If you meet the age criteria, you may start taking distributions without having to pay any penalty for early withdrawal.
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How Long Does A Payout Take
The amount of time it can take for your 401 k payout to come to you varies depending on the type of retirement plan you have. If your situation is uncomplicated, you can expect to receive the check within days. However, a more complex case might mean it takes up to 60 days if you request to receive the money via check.
Roll Over The Money To An Ira
You can roll over the funds to an IRA with a bank or brokerage firm. This IRA can be used every time you need to roll over a 401 without having to open a new account each time. The money will continue growing tax deferred and will be available for you in retirement. Some 401s allow for a post-tax Roth contribution. If your former contributions were going into the Roth, you can roll the money into a Roth IRA.
IRAs offer you more investment choices than 401s as you can invest in anything from stocks, bonds, mutual funds and more. There are many online platforms that enable investors to buy and sell investments on their own. But if this sounds like it is outside your comfort level, you can find a financial adviser who will help you manage your investments while planning for retirement.
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Youre Making Life More Complicated
Every 401k has its own specific rules, its own options, its own statements, its own online protocols, its own beneficiary forms, etc. Keeping separate 401k accounts means you have to keep up to date on all the particulars of each plan. Thats just adding more bureaucratic misery on top. Deciding what happens to your 401k when you quit your job is hard enough on its own. If you find that properly managing one account is challenging, think about how much more difficult managing several will be.
It will be almost impossible to maintain a consistent investment strategy across multiple 401ks at multiple providers. For example, lets say that you decide a 50%/50% split between stocks and bonds is ideal for your portfolio. If you have multiple 401k accounts, youll need to make sure that each of them is split 50%/50% to maintain that allocation across the entire portfolio. And what happens if one account has grown to the point where its 60%/40%, and another has become 30%/70%. If the values of those accounts are significantly different, it becomes a nightmare to determine what to sell and what to buy in each account in order to attain the 50%/50% split in our example.
See our blog post on Stocks and Bonds Diversification.
You Can Keep Your Plan With Your Old Employer
The first thing you need to decide is what to do with the money in your old plan. Option one is simple: you can leave where it is, in your former employers plan.
The major advantage of leaving it there is that you dont have to do anything and your account can stay where it is. The disadvantage is that you may be charged some of the fees that the company usually pays for but doesnt cover for ex-employees.
Also worth considering here is whether you left your old job on good or bad terms.
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Roll It Over To Your New Employer
If youve switched jobs, see if your new employer offers a 401, when you are eligible to participate, and if it allows rollovers. Many employers require new employees to put in a certain number of days of service before they can enroll in a retirement savings plan. Make sure that your new 401 account is active and ready to receive contributions before you roll over your old account.
Once you are enrolled in a plan with your new employer, its simple to roll over your old 401. You can elect to have the administrator of the old plan deposit the balance of your account directly into the new plan by simply filling out some paperwork. This is called a direct transfer, made from custodian to custodian, and it saves you any risk of owing taxes or missing a deadline.
Alternatively, you can elect to have the balance of your old account distributed to you in the form of a check, which is called an indirect rollover. You must deposit the funds into your new 401 within 60 days to avoid paying income tax on the entire balance and an additional 10% penalty for early withdrawal if youre younger than age 59½. A major drawback of an indirect rollover is that your old employer is required to withhold 20% of it for federal income tax purposesand possibly state taxes as well.
