If you’re heading into a new job, don’t forget the 401(k) command.
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If you are among the millions of workers who have quit their jobs as part of the so-called great resignation that continues to be wasted in the labor market, make sure you don’t neglect your 401(k).
While you may have choices about how to handle retirement savings in your ex-employer’s plan, there are situations where the decision is made for you if you don’t take action — and it may not be in your best interests.
“It’s better to take care of this in the first couple of months than it is to move to a new job,” said Haley Tolitsky, certified financial planner at Cooke Capital in Wilmington, North Carolina.
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Workers continue to leave their jobs at near-record levels in search of better opportunities in a tight labor market. About 4.3 million people voluntarily left their jobs in May, about the same as in April and down just slightly from more than 4.4 million in March.
While not everyone has a 401(k) or similar retirement plan in the workplace, those who do should know what happens to themselves when they leave a job and what the options are — and what the options are.
You have three main options for an old 401(k)
In general, you have several options for your old 401(k) machine. You can leave it where it is, take it with you to your new workplace plan or IRA, or cash it out—although experts generally caution against doing so.
Perhaps the easiest thing you can do is leave retirement savings in your previous employer’s plan, if that’s allowed. Of course, you can no longer contribute to the plan.
However, while this may be the easiest immediate option if available, it may lead to more work in the future.
Basically, finding old 401(k) accounts can be difficult if you lose track of them. There is, by the way, legislation pending in Congress that would create a “lost and discovered” database to make it easier to locate lost accounts.
“It’s really common,” Tolitsky said. “People move on to a new job, have life changes going on, they forget about it, and 10 years later they aren’t even sure about it.” [the 401(k)] was with or who was the provider.”
Also know that if your account is small enough, you may not be able to keep it with your previous employer even if you wanted to.
If the balance is between $1,000 and $5,000, your former employer can transfer the amount to an individual retirement account, or IRA. If the balance is less than $1,000, the plan can cash you out — which could lead to a tax bill and an early withdrawal penalty.
“If you can avoid that, you don’t want to cash out your 401(k),” said Kathryn Hauer, CFP with Wilson David Investment Advisors in Aiken, South Carolina. “Doing this with a traditional 401(k) means you’ll likely pay a 10% tax penalty.”
Your other option is to transfer the balance to another eligible retirement plan. This could include a new employer’s 401(k)—assuming the plan allows it—or an IRA extension.
Know that if you have a Roth 401(k), it can only be transferred to another Roth account. This type of 401(k) and IRA includes after-tax contributions, which means you don’t get an upfront tax break as you do with traditional 401(k) plans and IRAs.
However, Roth money grows tax-deductible and not taxed when qualifying withdrawals are made in the future.
Matching contributions may not be yours
While any money you put into your 401(k) is always yours, the same can’t be said for employer contributions.
Equity vesting schedules — the length of time you must stay in the company for its matching contributions to be 100% yours — range from immediately to six years. Any uninvested amounts are usually forfeited when you leave your company.
Unpaid 401(k) loans can be tough
Among 401(k) plans that allow participants to borrow money, nearly 13% of people had a loan outstanding last year, according to Vanguard’s How America Saves 2022 report. The average balance was $10,614.
If you quit your job and don’t pay off that borrowed money, there’s a good chance your plan will require you to pay off the remaining balance fairly quickly. Otherwise, your account balance will be reduced by the amount owed – called “loan compensation” – and considered a distribution.
In simple terms, unless you’re able to find that amount and put it into a qualifying retirement account by the following year’s tax return deadline, it’s considered a potentially taxable distribution. And if you are below 59°C when you leave the job, you can pay a 10% penalty for early withdrawal.
About a third of employer plans allow former employees to continue paying off the loan after they leave the company, according to Vanguard. This makes it useful to check your plan’s policy.
Transferring a 401(k) may have unintended consequences
It is worth talking to a financial advisor before transferring your old 401(k). In addition to portfolio considerations such as investment options and fees, there may be planning consequences.
For example, there’s something called the 55 rule: If you leave your job on or after the year you turn 55, you can receive no-penalty distributions from your current 401(k). If you transfer money to an IRA, you generally lose the ability to take advantage of the funds before the age of 59½ without paying a penalty.
Additionally, if you are the spouse of someone who plans to transfer their 401(k) balance to an IRA account, know that you will lose the right to be the sole heir to that money. With a workplace plan, the beneficiary must be you, the spouse, unless you sign a waiver allowing her to be someone else.
Once the funds are in a rolling IRA, the account owner can name anyone a beneficiary without the spouse’s consent.