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What happens to your 401k investments when you quit? Well, there are many options for your 401(k) after you quit your job. It’s possible that you’ll be able to keep your account. You can also transfer the funds from your old 401(k) to a new account with your new employer or an individual retirement account (IRA). But you must first determine if you are able to participate in the new plan. You may also take any or all of the money out, but there would be significant tax implications.
Before deciding which path to take, make sure you understand the specifics of the choices available to you.
Leave it with your former employer
Many 401(k) plans encourage you to keep your money in your 401(k) when you leave your job if you have more than $5,000 in it. Bonnie Yam, CFA, CFP, CLU, ChFC, RICP, EA, CVA, CEPA, Pension Maxima Investment Advisory Inc., White Plains, New York, says that if the amount is less than $1,000, the firm will force the money out by issuing you a check. “When the sum is between $1,000 and $5,000, the organization must assist you in opening an IRA to hold the funds if you are being forced out.”
Leaving your 401(k) with a former employer might be a smart move if you have a significant amount of money invested. You could just leave it in there and enjoy the plan. However, c Consider any of the other options if you’re likely to forget about the account or aren’t pleased with the plan’s investment options or fees.
“When you quit a job and have a 401(k) plan managed by your boss, the default choice is to do nothing and continue managing the money as you had been,” says Steven Jon Kaplan, CEO of True Contrarian Investments LLC in Kearny, New Jersey. “However, this is generally not a good idea since these plans have very small options in comparison with the most IRA options.”
Transfer It to Your New Employer
If you’re in with a new company, find out if they have a 401(k) plan and when you’ll be able to apply. Before they can enroll in a retirement savings account, many employers expect new workers to work for a certain period of time.
Meanwhile, it’s easy to roll over your old 401(k) plan once you’ve enrolled in a plan with your new employer. By simply filling out some paperwork, you will make the administrator of the old plan deposit the contents of your account directly into the new plan. A direct transition, which is made from one custodian to the next, eliminates the possibility of owing taxes or missing a deadline.
You may also choose to have the balance of your old account paid to you in the form of a check. But to avoid paying income tax on the entire balance, you must deposit the funds into your new 401(k) account within 60 days. Furthermore, make sure your new 401(k) account is working and ready to accept contributions before you liquidate your old one. This is pretty vital. Trust me, you do not want to have to wonder what happened to your 401k along the line during the process of quitting.
What You should know
“If your new employer’s 401(k) scheme is well organized and cost-effective, consolidating old 401(k) plans into it makes sense. It gives you one less thing to keep track of,” says Stephen J. Taddie, managing partner, Stellar Capital Management LLC, Phoenix, Arizona. “Keeping it easy for yourself now makes things simple for your heirs later if they need to step in and handle your affairs.”
Another thing to keep in mind if you’re approaching retirement age: money in your current employer’s 401(k) is not subject to mandatory minimum distributions (RMD). RMDs apply to money in other 401(k) accounts and standard IRAs.
Read Also: NONFORFEITURE OPTIONS: A Step-By-Step Guide
Convert it to an IRA
You still have a decent choice if you’re not going to a new job or if your new employer doesn’t offer a retirement plan. Your old 401(k) can be converted to an IRA.
However, you’ll be responsible for opening the account with the financial institution of your choosing. The possibilities are almost endless. That is, you are no longer bound by the choices provided by your employer.
“The right to invest how you want, where you want, and in what you want is the greatest benefit of rolling a 401(k) into an IRA,” says John J. Riley, AIF, founder and chief investment strategist for Cornerstone Investment Services LLC in Providence, Rhode Island. “An IRA rollover has few restrictions.”
“In some states, such as California, if you are in the midst of a lawsuit or believe there is the possibility for a possible claim against you, you may want to leave your money in a 401(k) rather than rolling it into an IRA,” says financial planner Jarrett B. Topel, CFP, Topel & DiStasi Wealth Management LLC, Berkeley, California. “In California, 401(k)s provide more investor security than IRAs. In other words, creditors/plaintiffs will have a tougher time getting their hands on your 401(k) money than on IRA.”
After reaching the age of 59 and half, you can start taking eligible distributions from any 401(k), old or new. That is, you can begin withdrawing funds without incurring a 10% tax penalty for early withdrawal.
If you’re planning on retirement, now is a good time to start using your savings to supplement your monthly income.
If you have a standard 401(k), any withdrawals you take after age 59 and half are tax-free; that’s if you have kept the account for at least five years. Furthermore, if you have a dedicated Roth account, any distributions you take after age 59 and half are tax-free. But, it also has to be an account held for at least five years. Only the earnings part of your dividends is taxed if you do not fulfill the five-year requirement.
You will also take distributions from your 401(k) if you retire or change jobs before the age of 55. However, you would be allowed to pay a 10% penalty tax on the taxable part of your distribution. This may be all of it, in addition to income tax.
Those who retire after age 55 but before age 5912.1 and half are not subject to the 10% penalty.
When you reach the age of 72, you must begin taking mandatory minimum withdrawals from your 401(k). The sum of your RMD is determined by your estimated life expectancy and account balance. The IRS has a helpful worksheet to help you figure out how much you need to withdraw.
Cash it Out
You may, of course, simply take the money and leave. While nothing prevents you from liquidating an old 401(k) and taking a lump-sum distribution, most financial advisors strongly advise against it. It limits your retirement savings unnecessarily, and you’ll be taxed on the whole sum on top of that.
If you have a large amount of money in an old account, the tax cost of a complete withdrawal might not be worth it. Plus, you’ll almost certainly be hit with a 10% early withdrawal penalty.
“Other than having to pay normal income taxes and a 10% tax penalty before turning 55 (not insignificant considerations), few people recognize the time worth of (in this case, tax-deferred) money already saved,” says Jane B. Nowak, CFP, Atlanta, Georgia. “By taking a complete withdrawal, they are forcing themselves to ‘start all over’ when it comes to preparing for retirement. It’s generally a smarter option to leave funds in a savings account to rise tax-deferred rather than taking a withdrawal.”
“One just needs to look at both the pros and cons before deciding what happens to your 401k assets when you quit,” Riley says on what you would want to do with the money in a former employer’s 401(k) plan.