There are many things to consider when leaving a job. One of the most important is what to do with your 401(k).
Leaving a job can be an exciting event, especially if you are moving to a new employer or perhaps moving into retirement. A critical consideration is what to do with your 401(k) or similar type of employer retirement plan account. Ignoring this money is a potentially huge mistake, as is moving this money incorrectly.
In most cases, you have four main options for your 401(k) when leaving your employer.
Rolling it over to an IRA
This is often a solid option for many people. You can roll a traditional 401(k) to a traditional IRA, or a Roth 401(k) to a Roth IRA.
A direct rollover will have no tax implications. If you decide to roll some or all of a traditional 401(k) to a Roth IRA, this is a Roth conversion, and you will incur taxes on the amount converted.
Related: Roth IRA conversions in your 60s and beyond: what to know
Generally, an IRA allows you to invest in a wider range of options than a 401(k), which usually has a limited menu.
Additionally, an IRA will allow you to consolidate money from all 401(k)s from former employers into a single account, making it easier to manage these important retirement assets.
Note that it is desirable to do a direct rollover from the 401(k) to the IRA. You should request this option from your former employer.
There is also an option for the former employer to send you a check. With this option, you will need to deposit the check into an IRA within 60 days to avoid certain tax penalties.
Additionally, the employer will withhold 20% if the check is made payable to you; this amount must be added to your deposit to avoid tax penalties.
Roll the 401(k) to a new employer’s plan
If your new employer accepts rollovers into their plan, rolling your old 401(k) into a new employer’s plan can be a good option. This allows you to add this money to the amount you will contribute to the new employer’s plan moving forward. This can make managing your retirement funds a bit easier.
This option can also allow you to take advantage of the rule of 55 if you leave your new employer in or after the calendar year in which you reach age 55. This rule allows you to take penalty-free withdrawals at age 55, rather than waiting until age 59 ½.
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Leave the money with your former employer
If your account balance exceeds $7,000 your former employer must offer the option to leave your 401(k) money in the plan.
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This can make sense if the plan offers a solid, low-cost menu of investment options. Note, you will not be able to make additional contributions. Your old employer might also charge additional administrative fees that you were not charged as an employee.
Take a lump-sum distribution
This is always an option, but it is important to understand the tax ramifications.
- Distributions from a traditional 401(k) are subject to taxation as ordinary income at the federal level.
- Distributions from a Roth 401(k) will not be taxed if the account owner has met eligibility requirements, including being at least 59 ½ and it has been at least five years since their first Roth 401(k) contribution.
Note that those who are younger than 59 ½ will generally pay a 10% penalty on withdrawals, except those who fall under certain exceptions, such as eligibility for the rule of 55 or qualifying for certain medical or other emergency exceptions.
NUA is an uncommon choice
An additional option that might impact some of you is using NUA (net unrealized appreciation). This can come into play if you have company stock in your 401(k) plan.
In this case, you may be able to roll all of the money over to an IRA, but take a distribution on the company stock.
The company stock will be taxed based on its cost basis and distributed to a taxable account. After holding the shares for at least a year, you can sell them, and any gains above the cost basis will be taxed at preferred long-term capital gains rates, rather than as ordinary income if the shares had been distributed to an IRA.
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