Leaving Your Employer? Don’t Forget Your 401(k)

One of the great benefits of employment is an employer-sponsored retirement account, whether that’s a 401(k), 403(b), or similar. Many organizations offer a match, which amounts to free money dedicated to securing your retirement.

When you leave a job, for whatever reason, you need a plan for your old 401(k). This may sound obvious, but, according to one estimate, there are over 29 million retirement accounts with over $1.65 trillion in assets that remain unclaimed for a variety of reasons.¹

Although you have to manage a lot of moving parts when you leave a job, it’s important to you and your future to remember this one—and consider your options.

Option 1: Roll over to an IRA  

Rolling your 401(k) into a traditional IRA at an outside custodian is often the best and easiest option when leaving your job.

There are several advantages to this strategy.

• An IRA provides continued tax deferral, and you won’t owe taxes on the rollover.
• An IRA will often provide a wider array of investment options—including mutual funds, ETFs, individual stocks and bonds, and a host of other choices—compared to a 401(k), 403(b), or other employer-sponsored retirement account. You can invest in whatever will best serve your long-term strategy instead of being limited by the plan's options.
• Fees and expenses associated with an IRA will often be lower than your old employer-sponsored retirement account.
• It's very common for people to work for a number of different employers over the course of their careers, and an IRA can be a good place to consolidate a number of retirement plan accounts from old employers. 

One potential downfall of rolling the money to an IRA is the lack of creditor protection. A 401(k), some 403(b) plans, and pensions are generally off limits to creditors. This includes a judgment in a lawsuit, a credit card company trying to collect debt, or most other types of judgements.

Exceptions include the IRS trying to collect from you, or a judgement for child support. Creditor protection generally extends to all plans covered under the Department of Labor’s ERISA program.²

Option 2: Move the money to a new employer’s plan

If you’re leaving your employer to take a new position with another employer, you may have the option to roll your old 401(k) or other employer-sponsored retirement plan into your new employer’s retirement plan. 

You’ll want to consider a few questions to figure out if this is a viable option for you.

• Does your new employer allow for these kinds of rollovers? Many do, but it’s not guaranteed.
• Does the new plan offer good options for investment? Some employer-sponsored plans offer only higher-cost mutual funds.
• Is creditor protection an issue for you? If so, rolling this money into another 401(k) is likely a better option than rolling the money into an IRA with more limited creditor protection options. 
• Are you nearing your required beginning date for required minimum distributions (RMDs)? If so, rolling your old plan into your new employer’s plan would defer your obligation to take RMDs from that account until you leave the new employer. In fact, if your new employer allows these kinds of rollovers, you might consider moving money from an IRA into this new employer’s plan in order to take advantage of deferring those RMDs. (Note: An employer must specifically offer the option to defer RMDs for active plan participants who have reached their required beginning date for RMDs. This clause must be included in the plan document. Only participants who are active employees and who do not own 5% or more of the business are eligible for this benefit.³)

Option 3: Leave the money where it is

If the investments offered in the old employer’s plan are outstanding and very low cost, and you think you’d have trouble matching the quality of these investments in an IRA or a new employer’s plan, leaving the money where it is could be your best option.

Before you commit to this plan, though, it's important to understand how the money will be treated by your old employer. Some plans treat money held by former employees left in the plan differently than money held by active participants.

Option 4: Take a distribution

You can certainly take a distribution of some or all of the money in your account when leaving your employer, but be sure you understand all the potential ramifications of doing so.

Distributions from a 401(k), or another traditional account such as a 403(b), will be subject to taxes regardless of your age. If you’re under the age of 59 ½, there may also be a 10% penalty on the amount withdrawn, in most cases). 

The rule of 55

The rule of 55 says that if you're 55 or older, you can withdraw money from your 401(k) or 403(b) without incurring a 10% penalty—as long as your leave your job within or after the calendar year when you turn 55. This only applies to the plan of your most recent employer; it doesn’t apply to any other old 401(k) plans or to IRAs. But, the rule stays in effect for withdrawals from your most recent employer’s plan, even if you subsequently get a job with another employer.

If you know you’ll be leaving your current employer at age 55 or older (or during the calendar year when you turn 55), you could potentially also move money from prior employers' plans into that account and withdraw funds without a penalty.

Public safety officers such as police officers, fire fighters, EMTs, and some others generally get an extra five years; this rule goes into effect at age 50 for them.

Especially if your departure from your employer is unplanned, the rule of 55 offers a way to avoid the normal penalties on 401(k) withdrawals. However, if you don’t need the money right away, you might be better off rolling it over—or otherwise keeping it invested so it could hopefully continue to grow. 

Conclusion

It's important to ensure that you make an affirmative decision as to what to do with an old 401(k) or similar retirement plan when leaving your job, and that your choice is made in line with your overall financial strategy.