What to Do with 401(k) When You Quit or Get Fired

When you leave your job, whether you quit or you get laid off, there are many things you need to do, including deciding what to do with your 401(k). You have the choice of leaving the 401(k) funds in your current plan, cashing out of the plan, or rolling the funds over into another qualified retirement account. Your employer will likely give you a packet with all of the necessary information to properly manage your options.

First, find out if you are fully vested. You are always entitled to the money you contributed to the plan, but you may not be eligible for all of the employer’s matching contributions. If you worked there for a few years, the chances are that you’re 100% vested.  Once you know your vesting position, you can explore your options.

According to the GAO, separating 401(k) plan participants generally have up to four options for their savings.

4 Things You Can Do with Your 401(k)

1. Leave the Money in Your Old 401(k) Account

This sounds simple, but unless your old plan is extraordinary, it’s probably best not to use this option.

• First, your former employer probably doesn’t want to deal with the hassles and expenses of administering your account. They may pass more costs on to you, which erode your real returns.
• Second, you may find it more challenging to get help when you need it.
• Third, you will not be able to borrow against your 401(k) balances. This is not necessarily a bad thing, but it does leave you with less flexibility (here’s an article that discusses why borrowing from a 401k is bad).
• Lastly, this will be one additional account that you’ll have to track and manage. And you won’t even be able to make new contributions to the account to make its management worthwhile.

Also note that if your balance is below a certain threshold and you do nothing, your employer may close your account and send you a check. This will put you in a situation similar to the Cashing Out option below.  Try to avoid this, since it will give you much less time to react.

2. Roll the Money Over to Your New Employer’s Plan

This option is not always available, and most likely not the best choice either. In general, 401(k) Plans have limited investment options, and both the plan and investments are quite expensive. Your best bet is to pick option #3 below.

3. Roll the Money Over to an IRA

This is the best option of the four. You’ll be transferring the money into an IRA account, where you can fully control the investments and expenses.

For more details, see How to Rollover 401(k) to IRA.

4. Cashing Out

If you cash out without designating a qualified retirement account, such as a 401(k) or an IRA, the employer is required to withhold and send 20% of the money to the IRS. If you do not deposit the remainder into a qualified retirement account within 60 days, you will have to pay Federal and State income taxes and a 10% early withdrawal penalty if you are under age 59½.

To avoid these taxes and penalties, you have to figure out how you’re going to come up with the missing 20% and deposit the money in the 60 days window. You can recover the withheld amount when you file your tax return.

By the way, this is probably the worst possible thing you can do, and you should avoid this at all costs.

Direct vs. Indirect Roll Over

For many employees, this is the best option when changing jobs. There are two ways to rollover your 401k: direct and indirect.

• If you do a direct rollover (also known as a trustee-to-trustee transfer), there are no taxes, withholding, or penalties. A check is sent directly from your current 401(k) plan to the designated retirement account — i.e., your new employer’s 401(k) plan or your IRA. Remember that the option of rolling over to another 401(k) may not be available unless you find another job right away. You may need to open an IRA to complete the rollover.
• If you do an indirect rollover, a check will come to you, minus the 20% required withholding sent to the IRS. For example, if your balance is $100,000, your employer will send you $80,000.  To complete the rollover, you have to send a $100,000 check within 60 days to your new retirement account custodian to match the exact original amount. Any amount under $100,000 deposited into your new retirement account will result in taxes and a 10% early withdrawal penalty if you are under age 59½. The extra $20,000 that the IRS is holding will be returned to you when you file your tax return.

Bottom Line

Out of the above options, I recommend the direct rollover into an IRA.  When done correctly, you avoid taxes and penalties, and you don’t have to come up with the 20% difference as per the indirect option. You will enjoy a much wider variety of investment options and lower fees when you roll the money into an IRA account. These two factors will make it easier for you to achieve your asset allocation objectives and financial goals.

Related Articles by Other Bloggers:

• Deciding What to Do With Your 401(k) When You Change Jobs at Cash Money Life
• Left a job? Do a rollover at Wise Bread
• 401k Rollovers – Transferring Your Retirement Investments When Changing Jobs at Money Smart Life

Pinyo Bhulipongsanon

Pinyo Bhulipongsanon is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.