What to do with 401k after leaving a job?

What to do with 401k after leaving a job? You should have a plan for your 401k after you leave a company. There are several choices to plan your 401k after you leave a company. Before making a decision on your 401k,  you should carefully consider rules as well as advantages and disadvantages. 

1. 401k rollover to IRA

A. Have an IRA account before withdrawing your 401k fund.

If you decide to rollover your 401k to an IRA, you should have an IRA account before withdrawing your 401k fund.

You can roll your 401k from the previous employer over your IRA account. However, you need to pay attention to its rules.  

 The 401k fund after being withdrawn needs to be rollovered to another retirement within 60 days to avoid any taxes or penalty. Note that if you are under 59 ½ and have had your 401k contribution account for less than 5 years, you will have to pay tax as ordinary income tax, plus a 10% penalty when you withdraw. 

Hence, if you do not have an IRA account, but you decide to rollover your 401k to an IRA, you should open one before you request to withdraw your 401k in order to avoid any unexpected situations which can trigger taxes and penalties.  

B. Consider advantages and disadvantages of 401k and IRAs before making a decision on 401k rollover to IRA.

Plus you should consider advantages and disadvantages of 401k and IRAs before making a decision on 401k rollover to IRA.

For instance, with IRA accounts, you can have wider investment choices with low fees.  Many companies such as Fidelity, Charles Swabs, TD Ameritrade and Merrill Edge allow you unlimited trading of stocks, ETFs and mutual funds without fees. Also you may have some cash incentives when you open a new or rollover IRA with Fidelity, TD Trade and Merrill Edge. The cash incentives may vary depending on your fund.  

Moreover, IRAs account has fewer rules since you open and manage your own investments. In contrast, there are more rules both on the company and IRS for 401ks. For example, the company may limit the times of rebalancing your portfolio. Also, the IRS requires that 20% of the distributions from your 401k are withheld for federal taxes. This will trigger your higher tax bracket.  

In addition, It may not be easy to communicate with your company about a 401k investment plan. In a bad case, your 401k can be frozen for some years if the company you worked for went bankrupt.  

For the estate advantage, IRAs offer more payout options to beneficiaries. In contrast, 401k usually will be paid out lump sum to beneficiaries which increase the high tax rate. 

It will be a plus advantage if you are comfortable to make your own investment choices and manage your IRAs portfolios. Since IRAs offer more investment choices, you can invest in what you want.  You can get a higher growth on your investment. However, a higher return usually comes with a higher risk. On the other hand, companies usually offer fewer investment choices for 401k. Those investment choices are low risk that generally means low return.  

2.  401k rollover to new employer 

A. Consider the advantages and disadvantages of your former employer and current employer’s 401k plans before you decide to rollover 401k from the former employer to the new employer.

You should compare the 401k plans of the old and new company. For example, you should obtain information about the new company’s investments, term plans, expenses and then make a comparison to decide the better one. Also, you should consider the direct and indirect 401k rollover. 

B. How does a direct 401k rollover work? 

After you make a comparison between the plans, you decide to rollover your 401k from the former employer to the new employer. Then, you need to obtain your new company’s 401k information such as investment plan, address, your name, plus the 401k amount from the previous employer which you want to rollover. 

Then, you provide the information to your old company’s 401k administrator. After the former employer receives the information within 30 days, a check from the old company will be sent to you to the new company address. 

As soon as you get the check, you should give that check to your new company’s 401k administrator. The 401k administrator will help you to deposit the fund in the new 401k account soon in order to avoid a 60 days delay triggering tax and penalty on the non-qualified withdrawal.  

The direct rollover is recommended because it is more simple and safer than an indirect rollover. Hence, you should carefully consider which one works best for you. 

C. How does an indirect 401k rollover work? 

For an indirect 401k rollover,  you request your former employer to send a check to you directly. In this case, you do not provide any information about the new company as well as  your new 401k plan.  This method has a mandatory tax withholding since the former employer who you request for the fund withdrawal assumes that you cash out your 401k. As of the result,  20% can be withheld for federal taxes. The 20% withhold may push your tax rate higher.

Note that within 60 days, you have to rollover the fund from the check sent to you, plus the 20% withhold, not on the check, but from another source into a new 401k plan. Otherwise, you will have to pay tax and a 10% penalty for the withdrawal if you are under 59 ½. 

For example, you request $20,000 from your previous company’s 401k plan to rollover to  the new plan. 

Under a direct rollover, a check of $20,000 will be sent to you to your new company’s address. Then, you can give that check to your new company’s 401k administrator to deposit it in your new plan. 

Under an indirect rollover, a check of $18,000 will be sent to you and $2000 may be withheld.  Then, within 60 days, you have to deposit the $18,000 check and the $2,000 remainder from another source into your new qualifying plan. 

Usually, your previous company will issue a 1099-R for the transferred fund issued to you. If your account has at least $5,000, your new company usually allows you to rollover. If your account has less than $1,000, your previous company is allowed by federal regulation to issue a check to you. Then, you have to rollover it to your new plan to avoid any taxes and penalty. 

3. Leaving 401k with the former employer

You can leave your 401k with your former employer. However, you may consider some hardships of leaving your 401k with the former company. 

For instance, you cannot make a 401k loan from your former employer. Note that you are legally allowed to loan your 401k up to $50,000 or 50% of the total contribution, whichever is lesser. However, you have to pay back within 5 years to avoid tax and a 10% penalty if you are under 59½ .  

On the other hand, you may lose your 401k trackings after so many years you leave a company. It can cause a headache and many difficulties.  In a bad scenario, a company that you have a 401k account with may go bankrupt. Then, your 401k fund can be frozen for several years. This situation may become more complicated to your beneficiaries. 

4. Taking money out of 401K

This option is usually not recommended. However, if you decide to cash out your 401k when you leave a company, you should consider the following rules.

If you are no longer working, you need to be at least 55 years old to avoid a 10% penalty on pre-retirement withdrawal. 

If you are still working, you need to be at least 59 ½ to avoid a 10% penalty on pre-retirement withdrawal.  

Also, if you have a traditional 401k, you have to pay ordinary income tax. Hence, you should carefully consider cashing out your 401k in order to avoid any penalty and the withdrawals which can push your tax bracket higher. 

Finally, you have several options to plan your 401k after you leave a company. However, you should carefully choose the option which is best for you. Also, you should follow its rules to avoid tax and penalty on non-qualified withdrawal.

Questions and Answers – What to do with 401k after leaving a job?

1.  What should you do to rollover 401k to an IRA

You should open an IRA if you don’t have one before you withdraw the fund from 401k. You make a request to your former employer’s 401k administrator to issue a check to you. After you get the check, you have to deposit it to your IRA within 60 days to avoid any tax and penalty.

2. Can you leave your 401k with your former employer?

Yes, you can leave your 401k with your former employer. However, you need to consider the advantages and disadvantages. For instance, you cannot loan your 401k from your former employer. You may lose your 401k trackings after so many years you leave a company and so on. 

3. Can you rollover your 401k from your former employer to a new employer?

Yes, you can rollover your 401k from your former employer to a new employer. However, you should consider advantages and disadvantages between the plan before you make a decision. 

For example, If you are 72 year olds, but you are still working and your account is with your current employer, then requirement minimum distributions (RMDs) may not be required. However, if you own 5% or above of the employing company, RMDs must begin at age 72.

4. Which one is better : a direct or indirect 401k rollover?

A direct 401k rollover is more simple and safer when you decide to rollover your 401k from your former employer to a new employer. 

5. Can you cash out your 401k when you leave a company?

Yes, you can cash out your 401k when you leave a company. However, this option is not recommended because you have to pay ordinary income tax, plus penalty on non-qualified distributions.