You may be asking yourself, “what happens to my 401k if I quit my job?” “Do I lose the benefits of my old 401k plan?” If you find yourself asking these questions, you’re not alone. An ING survey discovered that 50% of American workers who had participated in an employer-sponsored retirement plan, such as a 401k, have left their account at their previous employer. Out-of-site-out-of-mind was never more true, and the practical consequence of leaving behind your 401k is the loss of control of an important asset, which in many instances can represent the lion’s share of your liquid net worth.
The cause is easy to understand; leaving an employer is a complicated enough proposition. When you leave your job, most people are too emotionally drained to worry about their 401k account. When they land somewhere, they’re just thankful and ready to sink their teeth into a new chapter of their life. The old 401k account is part of the “old” chapter, and therefore, is too often neglected.
The numbers here are extraordinary. It’s common for workers to move from one employer to the next every two or three years. Someone in their mid-40s could easily have worked for five to seven employers and left behind a 401k account each time they moved. One estimate puts the total of orphaned 401ks at more than $1 trillion on a national level. In fact, it’s not uncommon for these accounts to represent 2/3rds or more of someone’s retirement portfolio. That’s a lot of money to ignore, which poses some significant problems. Fully understanding the benefits of your 401k account and learning about the options available to you is key to maintaining your retirement nest egg. Let’s look at what actually happens in your 401k when you quit your job.
You Could Be Paying Outrageous Fees
On the surface, your old 401k plan might seem great. It may even include a lot of fancy bells-and-whistles. However, there is a very real possibility that your old employer threw in those bells-and-whistles without adding any real benefits. On top of that, your old employer could be using your money to pay for those. What do we mean by that? Well, every 401k is provided by some firm – typically an insurance company or mainline brokerage firm – and they can charge fairly hefty administrative fees, commissions, and service charges to maintain the plan. In most plans, those fees are being paid by the participants in some form of direct and indirect charges.
You May Not Have The Best Investment Options
Even if the fees are reasonable, your orphaned 401k offers only limited investment options. By their very nature, 401ks cannot provide access to every investment option available in the market. Instead, someone at your old employer (typically HR) or someone in the insurance company’s or broker’s back office decided which investment funds you could use. Leaving your money in an old 401k is leaving your money to the whims of the least common denominator in that process.
You May Lose Early Withdrawal Options
This is one of those risks you may not see until it’s too late. One of the many benefits of 401k plans is that they often allow “employed” participants an option to borrow funds or make early withdrawals. 401k plans usually provide a loan option where you can borrow from your own account without penalty or tax. But this option is only available to you if you’re still employed. When you are still employed, you may be able to actually withdraw funds without penalty if you’re at least 55. But once you’ve left employment, these options disappear.
You’re Making Life More Complicated
Every 401k has its own specific rules, its own options, its own statements, its own online protocols, its own beneficiary forms, etc. Keeping separate 401k accounts means you have to keep up to date on all the particulars of each plan. That’s just adding more bureaucratic misery on top. Deciding what happens to your 401k when you quit your job is hard enough on its own. If you find that properly managing one account is challenging, think about how much more difficult managing several will be.
It will be almost impossible to maintain a consistent investment strategy across multiple 401ks at multiple providers. For example, let’s say that you decide a 50%/50% split between stocks and bonds is ideal for your portfolio. If you have multiple 401k accounts, you’ll need to make sure that each of them is split 50%/50% to maintain that allocation across the entire portfolio. And what happens if one account has grown to the point where it’s 60%/40%, and another has become 30%/70%. If the values of those accounts are significantly different, it becomes a nightmare to determine what to sell and what to buy in each account in order to attain the 50%/50% split in our example.
See our blog post on “Stocks and Bonds Diversification.“
Your Old Employer Might Become Unstable
Fortunately, US law prevents a company from simply dissolving a 401k and taking your money. Still, that doesn’t mean your old 401k is insulated from problems with your old employer. And let’s face it, Covid-19 has taught us how fragile some employers can actually be.
If your old employer goes under, it will be a royal pain to access your retirement funds. You’ll get the money eventually, but that could be a long time. An even bigger concern occurs if your old 401k account contains a large amount of the old employer’s stock. If you own shares of your old employer and that employer gets into trouble, undoubtedly, the price of that stock will decrease, perhaps plummeting if a bankruptcy filing is needed.
What Happens To My 401k If I Quit My Job?
Fortunately, you do have options. Here are the four basic options for dealing with the money in your old 401k plan:
1. Leave the Money in the Old 401k Account
Because of the turmoil around job changes, this become the default option for many people, as we’ve discussed above.
Pros: If the costs of the old plan are really low and if the investment options are extremely good, this may be a viable option.
Cons: As we’ve discussed, you may be paying high fees, have restricted investment options and lose early withdrawal options.
2. Roll it Over Into a New Employer’s 401k Plan
This assumes the new plan that the employer offers would allow you to bring the old balance into the new plan.
Pros: Like option 1, if the costs are low and the investment options strong, then this may be a good option, and also make it easier to monitor both plan balances on one statement.
Cons: Also like option 2, you may be moving your money from one high-fee, low-option plan into another high-fee, low-option plan.
3. Roll it Over Into an IRA of Your Choosing
This is a very good option for most people. “Rolling over” simply means you transfer the balance from one qualified investment account into another, and it is very easy. If you roll over your 401 k account into a Rollover IRA, it preserves the benefits of most of the options above, and it avoids the downsides.
Pros: This preserves the tax benefits of the 401k, expands your investment options, can reduce expenses, and allows you to control your retirement nest egg.
Additional Benefits of 401k Rollovers: If you need to preserve the early withdrawal and loan options, there are other individual retirement plan rollover options that can be considered.
Cons: It can increase costs if you pick the wrong brokerage or insurance company for the rollover, but working with a 100% objective advisor should eliminate this drawback.
4. Cash it Out
When you leave your job, you do have the option to cash out the 401k account balance and take the money. In most cases, this will expose you to paying income tax and perhaps some penalty taxes, so it needs to be analyzed thoroughly. Anything you withdraw (not rollover) is taxable, and if you’re (under the age of 59 ½, will most likely face penalty taxes as well. If you take the money and then decide it was a mistake, you have 60 days to put it back into a qualifying retirement plan and avoid the income taxes and penalty taxes. But if you miss that 60 days, this is irreversible.
Pros: If you really need the cash, you have the option to do it.
Cons: You lose any benefits in the 401k.
What Happens to Your 401k When You Quit is Up to You
We believe it is critical to take control your nest egg. Ignoring the issue won’t make it simply disappear; even when you’re tired of the whole job transition process and focused on learning the ropes at your new job. In the end, you control what happens to your 401k when you quit. Fortunately, you don’t have to go-it-alone. This doesn’t need to feel like you’re venturing out into the financial wilderness all by yourself. If you seek the advice of a strong 100% objective financial advisor, you’ll be able to explore all these options and make the decision which is best for you. That’s what we do; we act as a fiduciary – a fancy term meaning that we always act in your best interest.
Hopefully, changing jobs means an upward step toward a brighter future. You can include your nest egg in that brighter future by making a few wise decisions. Just don’t leave this to chance; don’t abandon your old 401k; don’t let someone else take excessive fees out of your account and limit your options. We’re here to help and would love to chat with you.