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What Happens to a 401k When You Quit?
At a Glance
- A 401(k) is a retirement account with tax benefits.
- Options when leaving a job: leave it, withdraw (with penalties and taxes), or roll it over (e.g., into an IRA).
- Leaving the account behind may result in lost opportunities and lack of monitoring.
- Analyzing financial situations is crucial for choosing the best course of action.
Jobs come and go, and if you spent years dealing with a hard job, low salary and, perhaps, a toxic environment, you decided it’s time to quit your old job. But you remember you established a 401(k) account, and you worry that all your savings will become unavailable or they will be taken away from you if you give up on your job. So, what happens to a 401k when you quit? If you’re one of the Americans who decided to leave their job, here’s what might happen to the retirement account afterward.
What Is a 401(k)?
Before we get into it, let’s remember what a 401(k) account is. A 401(k) is a type of retirement account that allows an individual to start saving money for years in preparation for retirement. The investing account comes with several tax benefits, and you have the option of either getting a traditional account or a Roth account.
Employers offer this type of savings account in order to allow workers to save towards their retirement. You are able to contribute up to a certain amount every year, and it is possible to contribute to both a 401(k) account and an IRA in one year. The contributions you make to your savings account will be taken from your paycheck. It’s also possible to have money put into the account by the employer on your behalf if you get a 401(k) employer match.
Usually, a 401(k) plan does not tax the investment earnings until you decide to withdraw the amount from your account. Usually, this happens after you retire, as you’ll not always be allowed to withdraw any amount from it before your retirement. When it comes to Roth 401(k) plans, though, withdrawals have no tax.
What Happens to a 401k When You Quit?
So, you’ve decided to quit your job. What now? Very often, employees leave their jobs without considering what to do with their retirement account. As a result, they end up leaving that account behind, in the 401(k) plan of the former employer. The thing to keep in mind in this situation is that you will not be able to contribute to the account anymore if you quit. The money you contributed still belongs to you, though, so you have to think about what to do with it.
Usually, plans let employees who leave their job keep the funds in their accounts as long as there is more than $5,000 saved. When there is less than $5,000 in your account, you can get a check from the plan sponsor so your account can be closed.
Other people choose to leave the money they saved behind. After all, it’s very easy to simply walk away and forget about the 401(k) plan you made with the former employer. But it’s not the best thing to do. Basically, when you leave the account behind, you don’t monitor it anymore. Because of that, you don’t know what happens with your money, and this is not good considering that it’s money you worked for every month. Moreover, if you leave money in various 401(k) plan accounts you made with different employers, the issue may become even worse.
On top of that, one of the best things regarding these retirement plans is that some of them offer an employer match. As an employee, you have to find out whether the company offers such a thing. When you quit your job after establishing a 401(k), you will not receive the match anymore. You will have multiple other investment options. More often than not, these plans come with withdrawal rules that are quite strict, as well as limited investment options and pretty high fees. If you don’t get an employer match anymore, you should not simply forget about your 401(k) plan from the old employer.
With a 401(k) match, you will be able to keep the amount you contributed only if the money had been completely vested before your quit. Otherwise, it will end up with the former employer taking back all the unvested contributions. Fortunately, the money you contributed yourself will still belong to you no matter what.
Possible Next Steps
Just because the amount you contributed can stay in the old account you had with the former employer, it doesn’t mean it should remain there. You have different options for your contributions so the money is not abandoned on your old 401(k) plan.
Withdraw the Money
Of course, one of the most convenient alternatives you have is withdrawing the money. After all, it belongs to you, and you worked hard for it, so why not withdraw it and use it for other things?
Well, there are some things to keep in mind before you rush to withdraw your money, though. You might be allowed to withdraw it, but you shouldn’t really do so unless you are not in the best financial situation. The IRS will most likely penalize you for withdrawing the money, and you will owe some taxes on it too. In the end, this could add a total of about 50% of the account balance. That doesn’t sound so nice anymore, does it?
Analyze your current financial situation and see whether it’s worth withdrawing your contributions or not.
Roll It Over into a New Retirement Account
You should not leave the old 401(k) account the way it is with the old employer. Basically, if you have too many investment accounts, you will have more responsibilities.
There will be a lot of tax documents to wait for, as well as email addresses, beneficiaries, and addresses to update when they change. Also, it’s easier to manage investments when you have all of them in a single place rather than spread across different places.
If you get a new job that also offers you a 401(k) account option, you can roll over the old 401(k). This is a great thing to do, especially if the new plan has some unique investment options and lower fees. If there isn’t any 401(k) plan available, you can consider rolling it over into an IRA.
Ramit Sethi, financial expert and author of New York Times bestseller “I Will Teach You To Be Rich” recommends doing just this:
“The majority of people will choose to roll over the 401(k) funds into an IRA, or individual retirement account. From a tax benefit standpoint, the IRA works in a similar manner to the 401(k), minus the contribution from your employer, of course. And since it’s a personal IRA, you have full control of the account and investments.”
If you don’t want to do anything, you can simply leave your old retirement account as it is. You can just leave the money there as long as you contributed more than $5,000. Also, if the new employer plan or IRA doesn’t offer investment options with unique features or low fees, it’s better to leave the old account the way it is.
Furthermore, if there are stock shares of the old company in the previous 401(k), you should consult a tax professional and see what you can do with them.
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If you came here wondering “What happens to a 401k when you quit?”, now you know the answer. After leaving your old job, you can either leave the money where it is as long as you made contributions of more than $5,000, or you can withdraw it or roll it over to a new account. Whatever you do, make sure you carefully analyze the situation, so you don’t encounter any problems. Don’t hesitate to talk to a tax professional for help, especially if the old account has shares of the old company’s stock.