What happens to your 401(k) when you change jobs?

A recent study reported that more than a third of workers in the US changed or lost jobs since the start of the pandemic.1 When you stop working for an old employer, you may wonder, what happens with the funds in your 401(k)?

Balance in the Account

Usually, the default option is to leave money in your existing account and your old employer’s plan may have rules that allow even very small balances to stay in the plan.  However, if your account balance is under $5,000, the former employer can complete an “involuntary cash out.” If the amount was less than $1,000, the employer can send you a check in the mail for your account balance.  Before you deposit this in your bank account and start using it for spending, be aware of the tax consequences.  Any withdrawals from a retirement account (unless you were able to make Roth contributions) will be taxable at the same rate as your earned income.  In addition, if you are younger than age 59 ½, the money will be taxed with an additional 10% penalty for early withdrawal.  To avoid these taxes, you can complete a rollover by depositing this money in another retirement account within 60 days.  (More information on rollovers to follow.)  If you decide to keep the money, we recommend you set aside the amount of your estimated tax liability so you don’t get a surprise at tax time.

If your account balance was less than $5,000 when you left employment, your employer can move your money to an Individual Retirement Account (IRA) of their choice.  Any amount that you rolled over from a previous plan would not count towards the $5,000 minimum account balance.

Vesting

If your employer was contributing to your retirement account, it’s possible they had a vesting schedule in place.  This means the money they contributed to your account can be forfeited unless you stay employed with the company for a prescribed period of time.  Typically, this vesting period is three to five years, and some of the employer’s contributions may vest each year.  For example, the vesting schedule could be 20% of the employer contributions each year, beginning at two years of service.  In this example someone would be fully vested (able to take 100% of the employer contribution with them) at the end of six years.  If your employment ended prior to becoming 100% vested, you would forfeit the amount of employer contribution which had not yet vested, plus any earning on those non-vested contributions.  Keep in mind you will always be fully vested in the contributions you made to the plan as well as the earnings on those contributions.

Options

Most likely, unless one of the scenarios in the first section applies to you, your money will stay in the existing 401(k) account unless you take action.  The other options include: initiate a rollover of this plan to the 401(k) plan you have with your new employer or complete a rollover to an IRA.  When considering which option is right for you, we recommend you compare these factors between the different accounts:

  • Does the account give you plenty of investment options?
  • What kind of fees does the account have?
  • Do you have access to an advisor that can help you with investment choices (if this is important to you)?

The last factor is one we often discuss at Starks Financial Group – does consolidating the money simplify your life?  I frequently talk to people that have multiple, small, retirement accounts from old employers. Consider your own tendencies – will you really review statements and rebalance your investments among several different accounts?  From a behavioral finance perspective, you will likely have more success managing your retirement accounts if they are only in one or two places.  To get to that point, consider the factors I mentioned above and roll over old employer retirement accounts either to your current 401(k) or an IRA.

What if you had an outstanding 401(k) loan?

Some employers allow their employees to borrow from their 401(k) plans.  If you still have an unpaid loan from your retirement account when you change or lose a job, you likely will face the choice of repaying the loan balance within a short period or treating that balance as a distribution.  As discussed above, this distribution would be taxed as ordinary income and would be subject to the 10% early distribution penalty if you are under age 59 ½.  If this applies to you, it’s worth asking your former employer about an extension of time to repay the loan.  Otherwise, you may have the option to repay the loan to an IRA by the tax filing deadline of the following year (including extensions).

The Bottom Line

Changing jobs can lead to feeling overworked and stressed.  Once the dust has settled, take a look at your old 401(k) and consider the options.  It’s important to stay proactive to make sure the money is in an account that serves you best in terms of taxes, fees, investment options, and simplification.

-Kathryn Beach

Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.

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Sources:

https://fortune.com/2021/05/14/us-workers-changing-jobs-covid-pandemic-workforce/

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