What Happens to my 401(k) If I Quit My Job?
You have many options with your 401(k) when you quit your job. See what the right plan is for you.
Contributing Writer at Tally
December 15, 2021
Your 401(k) is probably a big part of your retirement plans. During your time with your current employer, you may have built up your 401(k) balance and taken advantage of its tax benefits and your employer match.
But now that you're considering a job change you may be wondering, “What happens to my 401(k) if I quit?” Do you lose it all or a portion of it? Can you roll it into a new retirement account? Can you simply withdraw the cash and invest it?
Read more below to help you decide what happens to your 401(k) and what the right action plan may be for you.
What happens to my 401(k) if I quit?
When you leave your job, many variables impact what happens to your 401(k) retirement savings. Let's dive into these factors and see how they may affect you.
How does employee vesting work?
Some employers match your 401(k) contributions up to a certain percentage of your salary. For example, a 100% match on up to 6% of your salary means if you earned $100,000 per year, your employer would match up to $6,000 in contributions each year.
The caveat is your workplace uses employer contributions as an incentive to keep you with the company. And some may require you to be with the company for a certain period before that money is officially yours. This is called vesting.
Typically, it takes three years to get fully vested in the employer match. However, it usually works on a sliding scale: 25% vested in one year, 50% vested in two years and 100% vested in three years.
In the third year, 100% of the employer match is yours to keep if you quit your job.
Can I roll it into my new job's 401(k)retirement plan?
Does your new job offer a retirement plan? If so, is it also a 401(k)? If it is a 401(k), you can do a direct rollover of your old 401(k) into the new employer's plan without paying a penalty.
To complete a 401(k) rollover, you usually file a request with your old 401(k) that includes your new 401(k) information.
What if my new employer has no 401(k) or I don't have a new employer yet?
If your new job doesn’t offer a 401(k) or you haven't lined up a new job yet, you may run into a small issue that requires a little more work. You can open a traditional individual retirement account (IRA) or a Roth IRA and roll your 401(k) from your former employer into one of those.
A traditional IRA is very similar to a 401(k) in terms of taxes, so this rollover is straightforward and tax-free.
If you open a Roth IRA, which you fund with post-tax dollars, this is called a Roth conversion. It will require you to pay income taxes on the rollover amount. The only exception is if you're rolling over a Roth 401(k), which would be just as straightforward as the traditional IRA.
Can I withdraw the cash from my 401(k)?
In many cases, save for vesting issues, you can withdraw all the cash from your old employer's 401(k) when leaving a job. Once you receive the funds, your investment options are wide open. You can open a brokerage account, invest in individual stocks or mutual funds, put it in a high-yield savings account (HYSA) or various other options.
Keep in mind, a cashout from the old plan can come with significant consequences:
You’ll pay income tax on any amount you withdraw, unless you're withdrawing from a Roth 401(k). This amount will depend on your tax bracket.
You'll pay a 10% early withdrawal penalty for the early withdrawal based on the lump-sum distribution. So, if you withdraw $10,000, the IRS would require you to pay a $1,000 penalty on top of income tax.
You’ll need to consider your previous employer's vesting schedule and anticipate a reduction based on that. If you're unsure of your vesting schedule, check with your plan administrator before cashing out.
As you can see, an early withdrawal may come with big-time fees, making it a last-resort option for many people. Consult a Certified Financial Planner to go over the potential downsides to a 401(k) cashout.
Are there any exceptions to the early withdrawal penalties?
Not all early 401(k) withdrawals come with significant penalties, as the IRS has a collection of exceptions.
Here are a few of the more common exceptions you may be able to take advantage of:
Disability: If you become permanently and totally disabled, you can withdraw from your 401(k) penalty-free.
Domestic relations: If a court issues a Qualified Domestic Relations Order, such as during a divorce, the withdrawal is exempt.
Education expenses: If you’re pursuing higher education, you can use your 401(k) to cover the expenses penalty-free.
Buying a home: If you're a first-time homebuyer, you can withdraw up to $10,000 from your 401(k) without penalties.
Medical expenses: If medical expenses make up more than 10% of your adjusted gross income, you can use your 401(k) to pay the bills exceeding that 10%. You can also pay health insurance premiums while unemployed from your 401(k) balance penalty-free.
Separation of service: If you leave your company after your 55th birthday, you can start taking 401(k) disbursements penalty-free.
The IRS has a complete list of its exceptions online — this is just a brief overview of some of the more common ones.
Managing your 401(k) after quitting — it’s your choice
You have many options to choose from when you quit a job with a 401(k) account balance. The key is to remember that what you do with your 401(k) is your choice.
Before deciding how to handle this valuable account, it's wise to speak with a financial advisor or Certified Financial Planner to review your options and the pros and cons of each choice for your specific situation.
This financial professional can help you decide if it makes sense to roll it into an IRA or another 401(k), cash it out, use it to fund a home purchase or simply retire a few years earlier than expected.
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