What Should You Do With Your 401k Plan When You Leave Your Job?

by Jason on June 28, 2010

“Mr. Jones, we appreciate your work for us, but unfortunately there’s just not enough room in our budget for you.

Here’s a packet of information regarding your retirement account.  Please look this over and have a decision made about your 401k plan by the 31st.”

Ever hear these words?

Maybe your company didn’t sound as nice, but the result was the same.

Or – perhaps you left on your own terms and are embarking on a retirement journey or looking for a new career path.

Any way you slice it, there is one question that remains:

“What should you do with your 401k plan?”

Let’s take a look at four options to help you make an informed decision on what you should do with your 401k plan upon retirement or separation from service whether you have a million dollars or several thousand.

Leave Your 401k Plan With the Current Company

Generally, you can leave your 401k with your current company – or should I say your previous employer.

But this isn’t always the case.  Many times, companies want you to get those funds out of there because of costs to them.

If your company does allow you to leave it – then you can just keep your 401k plan with the same custodian, use the same investments and keep things as is.

Advantage:

It’s easy, generally cost effective and doesn’t require much thinking on your part.  Just keep the status quo.

Disadvantage:

You have your money with your former employer’s custodian.  That could possibly make for some discomfort – even though your employer legally can’t do anything with your money, some folks would rather cut ties completely.

Your money is invested with whatever custodian your company chooses – and they can change whenever they want, to whomever they want.  That means your funds could change simply because your former company wants to change.

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Take a Distribution From Your 401k Plan

You could take money out of your plan, have a check cut and sent directly to you.  Perhaps you need the cash and are more worried about making ends meet with the loss of your job than you are about preserving your retirement future.

Advantage

Access to cash if you need it within a relatively short period of time.

Disadvantage

If you are under age 55 when you retire or separate from service there is a 10% penalty for early distribution.

If you are over 55 that is waived.  Yes, you read that right – age 55. This is called the age 55 Exception where the IRS allows you to take a distribution from a 401k provided that you are age 55 at the time of your separation from service and that you leave your 401k at your company – in other words you cannot roll it to an IRA first and then take distributions and expect to avoid the penalty.

There is also a mandatory 20% tax withholding from your custodian, which they will send to the IRS for you.

Take Your 401k Plan With You to Your Next Employer

One option you may have is to take your 401k plan with you to your next job.  You’ll have to check with your new employer to find out if this is allowable, but generally speaking many plans will let you transfer that old 401k into the new plan.

Advantage

Easy.  Combining your funds helps with compounding interest earned on that 401k balance.  There are no tax consequences.

Disadvantage

The new company may not have the greatest 401k plan available.  There may not be a good variety of funds.  Again, the custodian can be changed at the employer’s discretion, which means you still don’t have much control over your funds.

Roll Your 401k Plan Over to an IRA

You can do a direct rollover to an Individual Retirement Arrangement or IRA.

Advantage

You are in the driver’s seat.  The money is in your own account which you have discretion.  You can make changes, you can make the investment choices, you can pick the custodian or brokerage company that you feel most comfortable.

You don’t have the company limiting your investment options.  You can invest into pretty much anything you want.

You can even open a Roth IRA and do a Roth IRA Conversion on the money if you wanted to – you are making decisions, not your employer any more.

There are no tax consequences to performing a direct rollover.

Disadvantage

This requires a bit more work on your part.  For example, you’ll need to research a custodian, research investments – whether it is stocks, mutual funds or ETF’s.   You’ll need to essentially manage your own account unless you hire a professional to help you, which of course you’ll have to pay fees to do so.

The 401k generally allows for creditor protection in a bankruptcy or by plaintiffs in a civil lawsuit. IRA funds, however, are limited in their protection and the rules differ from state to state.

What Are Your Thoughts?

As you can see, there are some decisions to make once you leave your job. Some of these are more advantageous than others, so be sure you do your homework and figure out what’s best for you for your retirement.

Readers, what would you do – or what have you done in this situation?

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