If you recently switched jobs or retired, you might be wondering what to do with your old 401(k) plan. While any and all contributions made by YOU are 100% yours right away, the length of time that you were with your old employer can determine whether the funds contributed by your employer are partially or fully vested. Generally, it takes three to six years to become 100% vested. 

You have four options with a 401(k) when leaving your job or retiring. You can keep the 401(k) with your former employer, complete a 401(k) to IRA rollover, directly transfer your 401(k) to a new employer’s 401(k), or cash out the 401(k).

But which option is best? Check out the pros and cons of each option below so you can make an informed decision for your specific situation.

1. Keep your 401(k) with your former employer. 

Most companies allow you to keep your 401(k) with them even after you no longer work there (however, not all companies offer this feature). 

Pros

  • Your money will continue to grow tax-deferred.
  • No penalties for withdrawals (age 55 or older).
  • Federal law protects against creditors.
Cons

  • Lower 401(k) amounts (less than $5,000) can be automatically cashed out or placed in an IRA
  • You cannot add money to the account
  • You cannot take out a 401(k) loan
  • Partial withdrawals may be limited
  • Limited to the investment options offered by that employer’s plan 

 

2. 401(k) to IRA rollover

You have the option of rolling your former 401(k) into a rollover IRA that you can open at any brokerage firm or financial institution. 

Pros

  • Your former 401(k) can grow tax-deferred
  • Use IRA funds for a qualifying first-time home or educational expenses (no age penalty)
  • More investment options available 
Cons

  • There is more federal protection for a 401(k) than an IRA

 

3. Former 401(k) to new employer 401(k) rollover

If you are interested in rolling over your 401(k) into your new employer’s plan, you will first need to ask if your current employer allows you to do so. Then, suppose you have the capability; it’s essential to complete a direct rollover. A direct rollover involves your 401(k) brokerage sending a check directly to your new 401(k) brokerage. The payment will include instructions regarding the rollover.

It would be best if you did not have the 401(k) check sent directly to your address. However, if the check has your name on it (indirect rollover), the IRS requires your employer to withhold 20% in taxes, you will only have 60 days to place the money into a new 401(k) or IRA, and risk coming up with the 20% out of pocket or face further penalties.

Pros

  • Money can continue to grow tax-deferred
  • Only having one 401(k) is easier to manage and may decrease overall maintenance fees
Cons

  • Not all employers give you the option to rollover from a previous employer’s 401(k) plan
  • Your new 401(k) plan might not have as many benefits or be more expensive to manage than your former employer’s 401(k) plan

 

4. Cash out your 401(k)

You might cash out your 401(k) if you are transitioning jobs or retiring. The extra funds would help with moving expenses, lifestyle costs, and even paying off accrued debt. Unfortunately, cashing out your 401(k) should only be used as a last resort. Ensure you have exhausted all other options, and only use your 401(k) if you have an emergency need for cash. Cashing out a 401(k) before age 59 ½ could cost you over 40% of your retirement savings (penalties include early withdrawal, federal taxes, and state taxes). The early withdrawal penalty is waived if you were no longer working for your former employer in or after reaching age 55 but are not yet the required 59 1/2. If you need only a fraction of the cash, check to see if your former employer allows partial withdrawals. You also have the option of rolling the account into an IRA to access a portion of the funds.

Pros

  • Quick emergency cash
Cons

  • Possible early withdrawal fees
  • Possible tax implications
  • The former employer may not allow you to access only part of your 401(k)
  • Reduction in retirement savings

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