Whether you retire, change jobs, or even get fired, you’ll have a few options for your 401k. While it is generally up to you, what happens to your 401k when you leave a company is also dependent on why you leave and how long you’ve been there. You won’t have a choice on some things. However, understanding the rules and options can help you make a more informed decision regarding the timing of your departure.
To understand the big picture you’ll first need to understand how much of your 401k balance actually belongs to you. The next step will then be to know the options to choose from.
More than likely your 401k balance contains your own contributions as well as additional contributions from your employer. Your own contributions belong to you, always. You earned this money as compensation, but chose to save it in the 401k rather than receive it in your paycheck. Placing that money in your 401k doesn’t make it any less yours.
Your employer contributions are different. Employer contributions are more commonly called matching contributions. This money is in addition to what you earned as wages, and may not belong to you… yet. When you leave your employer for any reason they may take back some of those matching contributions.
How much of the employer matching contributions will you get to keep? That depends on your company’s vesting schedule.
Perhaps the most important thing to consider is the vesting schedule. The vesting schedule lays out the timeline on which those employer matching become yours, or vest. Vesting is stated in terms of a percentage of the amount your employer has matched.
Suppose your employer has contributed $100,000 in matching contributions. If you are 40% vested, then you get to keep $40,000 of that money if you leave. The employer will take back the remaining $60,000.
Different employers have different vesting schedules, and you can find yours in the plan documents. There are rules that prevent the company from drawing out that timeline too long. Those rules also depend on the type of vesting schedule; cliff or graded.
It is possible that your plan provides immediate vesting, which means your employer contributions are 100% yours as soon as they hit your account. This is of course the most favorable vesting schedule.
If you’ve been with your employer for several decades then the vesting schedule isn’t a concern of yours.
In a cliff vesting schedule, none (or 0%) of the employer matching contributions belong to you until you reach a certain point, and then they ALL belong to you.
The most stringent a cliff vesting schedule can be is a 3-year cliff. With this schedule you’ll be 100% vested after completing your third year with the company. Your employer can provide a cliff schedule that is more favorable to you, such as a 2-year cliff, but not one that requires you to wait longer than three years.
Unlike a cliff vesting schedule, a graded vesting schedule gradually increases the vesting percentage over time. A graded schedule cannot be less favorable to you than a two to six year schedule. This schedule vests your money at a rate of 20% per year starting after the second year. The employer match is 100% vested after the sixth year.
Why Does the Vesting Schedule Matter?
When you leave your company for any reason, you get to take your own contributions with you. However, you only get to take the vested portion of employer matching contributions. Your employer will deduct any non-vested matching contributions.
What Happens Next?
You’ll need to decide what to do with the money in your account. You can either cash out the account, roll it into an IRA, transfer to your new employer, or leave it where it is.
Generally not the best option. You’ll be taxed on the entire amount you withdraw plus a 10% penalty unless you meet one of the exceptions. If you want to cash you just let your HR department know. They will either give you a form or direct you to an online portal to fill one out. The 401k plan administrator will then issue a check or direct deposit to your bank.
Rollover to an IRA
Most people will choose to roll an old 401k into an IRA. This gives you the most flexibility. It isn’t tied to an employer, and you don’t have to transfer it when you change jobs or retire.
This is a pretty simple process that you can usually accomplish quite painlessly. You’ll need a recent 401k statement. Unless you have a paper copy you can get one from your account online if you have set that up, or check your email if you have opted to receive paperless statements.
If you work with a financial planner they will step you through the process. If you roll it into an IRA at an online or discount brokerage they will also have instructions for you to follow.
Either way you’ll need to first open an IRA if you don’t have one, and then initiate the transfer. Most places can do this all in one step. A rollover is also not initiated with your HR department. You initiate the rollover with the receiving financial institution who will then coordinate the transfer.
If you leave your company because you have retired, make sure to pay attention to age restrictions on different account types. You wouldn’t want to start retirement off by setting yourself up to take a big tax penalty on withdrawals. If you are under 59 & 1/2, it could make sense to leave the money in your 401k for a few years. Distributions from a 401k are not subject to the 10% early withdrawal penalty. You need to be over 59 & 1/2 to avoid the 10% penalty on an IRA. Remember too that you will have to take RMD’s from a Roth 401k, but can avoid that by rolling over to a Roth IRA.
Transfer to a New Employer
Unless you are retiring you may have the option to roll your 401k into the plan with your new employer. Check the plan documents or ask HR if they allow this. As long as your employer has a good plan with decent investment options this may not be a bad decision. It certainly makes things easier when you have fewer accounts to keep track of.
Leave the 401k with the Old Employer
Unless you have a very small balance in your 401k you may have the option to just leave it at your old employer. That doesn’t mean the money is no longer yours. It’s still there in an account titled in your name, and it’s still invested however you chose to invest it.
The issue will be that it could be much more difficult to do anything with the account. Barring the need to wait until you are 59 & 1/2 to roll it over due to the 10% penalty discussed above, there is very little reason to just leave an old 401k with an employer.
Word of Caution
Before you withdraw money from a 401k or roll it into an IRA make sure to check for employer stock in your account. Appreciated employer stock receives very favorable tax treatment, but only when held and withdrawn from your employer-sponsored plan.
If you roll it over into an IRA or sell it and withdraw the cash you could potentially cost yourself thousands in taxes.