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.
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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.
Your focus naturally shifts toward your current employer and their retirement savings plan. Some employers offer multiple retirement plans such as 401ks, pensions, profit sharing plans, stock options, stock grants, etc. The choices can be overwhelming but also very profitable, especially if there is an employer match. You need to figure out where and how much to contribute to the retirement savings plans available at your new gig. We suggest doing this while you’re learning the details of the new job and the names of your co-workers.
It is very common to forget about your old 401k account. It’s part of the “old” chapter and, therefore, is too often neglected while you look ahead to your bright new future.
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 nationally. 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 details of your old 401k account and learning about your options is key to keeping your retirement savings on track. Let’s look at what actually happens in your old 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 has become the default option for many people, as we’ve discussed above. You don’t have to worry about incurring withdrawal penalties or decide whether to take a lump sum distribution or annuity payments.
Pros: If the costs of the old plan are really low and 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 option assumes the new plan that the employer offers would allow you to bring the old balance into the new plan.
Pros: Like option 1, this may be a good option if the costs are low and the investment options are strong. It would 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 an excellent option for most people. This option is called a “Direct Rollover.” It simply means you are transferring your 401k balance in your old plan directly into a new 401k plan or IRA (Individual Retirement Account) you set up.
Most employers offer this option. Check with your previous employer’s HR department if they have not already sent you an explanation of your options. Ask them for the distribution form. Most are fairly simple to complete. Turn it in, and your money will move from one qualified retirement plan to the next qualified retirement plan.
In technical terms, you’re taking a lump sum distribution in the form of a direct rollover. There’s even a technical name for the new IRA. It’s called a Rollover IRA, and by using this type of account, you preserve the benefits of most of the options above while also avoiding many 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. It also avoids any withdrawal penalties, which can be severe.
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. This is also considered a lump sum distribution, but in most cases, it is the worst option. We realize the terms are similar here, so let’s emphasize again that a lump sum distribution as a direct rollover is great; a lump sum distribution that you either take and spend or deposit into a regular savings account should be avoided.
Pros: If you really need the cash, you have the option to do it.
Cons: You lose any benefits in the 401k, and you can incur substantial taxes and penalties.
If you do not roll over the money into another qualified retirement account, you will, in most cases, pay income taxes on the full amount of the withdrawal. There can also be potential early withdrawal penalties.
If you’re considering taking the money, you should work with an objective advisor to fully explore the costs. They can be as high as 62% in the top tax brackets.
Anything you withdraw (not rollover) is taxable. Everything withdrawn in a calendar year is taxed as regular income for that year. This 401k withdrawal can easily bump you into a higher income tax bracket. Depending on your state of residency, these income taxes could be 50%.
If you’re under the age of 59 ½, you will most likely face penalty taxes as well. The federal “early withdrawal” penalty can be 10%, and in some states, there is an additional 2% penalty at that level. Combined, that’s another 12% in taxes.
Put this all together, and the combined federal taxes, state income taxes, and early withdrawal penalties can reach 62%.
There is some potential relief here if you determine you’ve made a mistake soon enough. You have 60 days to put the withdrawn money back into a qualified retirement plan (Rollover IRA) and avoid the income taxes and penalty taxes. The 60 days are strictly enforced and begin on the date of the withdrawal. If you don’t put the money back into a qualified retirement account within the 60-day window, it is an irreversible mistake. You are also restricted to making one of these redeposits every calendar year. If you have two old 401ks and make this mistake in both retirement accounts, you do not have the 60-day window for both. One time per year, and that’s it.
What Happens to Your 401k When You Quit is Up to You
We believe it is critical to take control of 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 at 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 that 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. By making a few wise decisions, you can include your nest egg in that brighter future. 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.