THREE 401(K) OPTIONS WHEN YOU LEAVE A JOB
Updated: Jul 30, 2021
When you leave your current job, there are three options available to you for the money you have inside of your current employer's plan. Each option has its pros and cons. You should consider all of the nuances before choosing an option that would work best for you.
First let's understand the different money types you may have in your plan.
The first type is your own income deferral, often labeled as EEDEF on your statement. This is part of your own salary you chose not to receive (and pay taxes) and it is being held in the plan to invest and grow for retirement. This money is always 100% vested to you.
Many employers offer company Match to what you contribute or they just give you money in the plan anyway regardless if you contribute yourself. If these monies are under a Safe Harbor option they are also 100% vested to you. It's pretty confusing having to navigate all that uncharted waters but your plan statement should indicate which money is yours and which ones have not fully vested. Vesting is often tied to a schedule based on how long you've worked at the company. 6 years is common. You can not take unvested portion with you when you leave the company. However if you come back to work for the same company within a certain period you may continue on the schedule and allow more money to vest.
Lastly, you may also have Profit Sharing contributions in your plan. These are company dollars paid to you as a share of the profit.
So after identifying the type of money and what's vested for you here are some of your options.
Option 1. You can leave it in your existing 401(k) under your current company’s management. This is the most straightforward and simple option. You'll have the same online access, a familiar user interface, your managing advisor team and the custodian customer service will also remain the same. Sometimes if the investment is doing well and you like the investment option it also makes sense to leave it where it is. In my practice I often encounter people with two or three small 401(k)s from their previous employers. If you have company stocks that are not offered elsewhere you can leave them in your existing 401(k) plan. Just make sure you review all of your plans periodically and coordinate your investments towards the common goal.
Option 2. You can roll over your existing 401(k) to a new 401(k) if your new company sponsors such a plan and allows participation from day 1. This can be a good option if you like the new funds offered or if you plan to take out a 401(k) loan and needs the high balance. You can borrow up to 50% or $50,000, whichever is less. Some of my clients have used this option to pay off their high interest credit card debt or as a down payment for their home. Borrowing from a traditional IRA is not permitted. This option will not work if your new employment is contractual, does not offer a 401(k) plan or do not participation until a later date.
If you already have a 401(k) loan leaving your job can be complicated. When the employment relationship is severed any 401(k) loan is due immediately. You can pay it back or roll it over to a new 401(k), provided that your new employer sponsors one and allows participation from day 1. Otherwise your previous employer will issue a 1099-R and the loan will be treated as a distribution which is subject to income tax and 10% penalty if you are younger than 59 ½ years of age.
Option 3. You can roll the money over to an advisor or self-managed IRA account. This option may allow access to many more investment options beyond what your 401(k) plan offers. You may create a greater degree of relancing and diversification options. For an advisor-managed IRA you may incur additional fees paid to the advisor so be sure to take the time to interview the advisor and make sure they listen to your preference and work with you to engineer a portfolio with high quality and low cost mutual funds. For a self-managed IRA you are on a DIY model and you'll have to rely on your own research and available information to make important decisions. This works for some but many prefer to have professional management and focus on what they do best.
Option 4. You can take the money as a cash distribution. This option will add the distribution amount to your current year taxable income and is taxed at the highest marginal income tax bracket you are in. If you are younger than 59 1/2 years old the IRS will also impose a 10% early distribution penalty unless you meet certain exceptions.
Advancing to a new career is a great opportunity to start working with a financial professional. Developing the next focus in life and aligning your financial activities to that focus is the key to success in retirement. 401(k)s and IRAs are great tools that must coordinate with your other assets to maximize your net after tax retirement income.