Options for Your 401(k) Account When You Switch Jobs

Dubbed the “Great Resignation”, many employees are taking an opportunity these days to find a different job that better fits their lifestyle and goals. If you have a 401(k) account with your current company and decide to leave, you have some decisions to make. Here are your options:

1. Leave the account with your old employer. This option has some caveats – if your balance is below a certain threshold (up to $5,000 depending on your plan’s provisions), you could be forced to take a distribution of your account within a specified amount of time. But if you have a larger account balance, and you’re happy with the investments you’re in, you might consider leaving the account as is, at least for a while. However, you won’t have as much flexibility and control over your account you would have compared to some of the other options below.
2. Roll your account into an IRA. This option provides you with the most flexibility and control. If your 401(k) contributions were made as Roth (after-tax) contributions, you can transfer those amounts to a Roth IRA. Any employer contributions such as a match, as well as your own pre-tax 401(k) contributions, can be rolled into a traditional IRA without incurring any taxable income. You’ll want to do a direct rollover from your plan to your IRA without taking possession of the funds yourself to avoid receiving a lower amount (see option #4).
3. Roll your account into your new employer’s 401(k) plan. Before doing this, check with your new employer to ensure their plan allows rollovers and the timeframe for making a transfer. For instance, check whether you’re allowed to roll over your old 401(k) before becoming eligible for the new company’s plan. You’ll want to do a direct rollover from one plan to another without taking possession of the funds yourself to avoid receiving a lower amount (see option #4).
4. Take the money. In general, this option will mean that 20% of your account will be automatically withheld off the top to pay taxes, paying out only 80% of your account balance. If you made pre-tax 401(k) contributions, you’ll be taxed on the distribution amount at your ordinary income tax rate. Taking a distribution before you reach age 59½ can incur an additional 10% penalty over and above your ordinary income taxes. Not to mention that your 401(k) distribution may also incur state income taxes depending on where you live. And if your account balance is large enough to put you over the applicable income threshold, you could be hit with an additional 3.8% net investment income tax (NIIT).

If your contributions were made to a Roth 401(k), withdrawals can be made without penalty or tax consequences as long as you are at least age 59½ and have had your account for at least five years. But if that’s not the case, you’ll have to pay taxes plus a 10% penalty on the earnings (but not on your contributions, since you paid taxes on them before they were added to your plan account).

Regardless of which option you choose, you’ll receive a Form 1099-R by January 31 of the year following your distribution. This form will notify the IRS whether your withdrawal was taxable or whether you rolled it over.