Answering these questions can help you navigate what to do with your 401(k) when you switch employers.
“If I leave my job to freelance or take another job, what should I do with my retirement account? I won’t lose the money, will I?”
— Jennifer, Brooklyn, New York
Before you leave, it’s important to understand the (potentially negative) impact on your retirement savings. If you don’t, you could stand to lose significant dollars. Consider these questions:
Are you vested?
The money you contribute is always 100 percent vested, but your company match usually vests over a period of several years — typically three to five. If you leave, you may forfeit a portion or all of your employer’s match, plus any earnings on that match.
Do you have an outstanding loan from your 401(k)?
If so and you leave, you’ll owe the balance of the loan quickly — typically within 60 days. If you don’t pay it back in time, it’s considered a distribution and you’ll owe taxes on it plus a 10 percent penalty that year.
Do you have less than $5,000 in the account?
If so, you’ll want to roll over the money immediately or your former employer may distribute it to you directly, automatically withholding the IRS-required 20 percent. In that case, if you do not roll over the entire amount within 60 days and you’re under age 59 ½ you’ll end up with a 10 percent tax penalty in addition to any taxes you may still owe.
Does your new employer have a retirement plan?
If so, you may want to rollover the money in your old plan to the new one. Find out when you’ll be eligible to participate, and put some thought into what your new investments will be. If there’s a waiting period, you can leave your funds in your old employer’s plan in the meantime. But to avoid a tax headache, make sure all rollover checks are written out directly to the new plan administrator, NOT to you.
Do you think you’ll need the money post-departure?
You should reconsider since it’ll cost you in the short and long run. If you cash out your plan, you will owe taxes and a penalty (see above). Plus it could be a huge setback in saving for retirement. In other words, don’t do it!
In most cases, the best strategy when changing jobs or going freelance is to rollover your 401(k) to an IRA or Roth IRA. This way you can have more control and a wider variety of investment options with potentially lower fees and expenses. You can also continue to contribute to your account, which you would not be able to do if you left it with your old employer.
If you already have an IRA set up to receive the rollover, great. If not, you can easily open one at virtually any financial institution. Just make sure to have your administrator send a check directly to the new administrator to avoid that tax headache and remember that if you roll to a Roth, you will owe taxes on the amount rolled that year. Good luck!