When you quit a job, your retirement funds, such as a 401(k), do not disappear; you typically have several options for managing them to continue their growth and avoid penalties. Deciding what to do with your retirement savings is an important financial decision that can significantly impact your long-term financial security.
Generally, you have four primary options for your retirement savings when you leave an employer:
1. Leave It with Your Previous Employer
In many cases, you have the option to leave your retirement savings, such as a 401(k), in your former employer's plan. This might be a viable option if you are satisfied with the plan's investment options and low fees, or if your balance is substantial. Some plans, however, may automatically roll over or cash out small balances (e.g., under $5,000) if you don't take action.
- Pros:
- No immediate action required, preserving tax-deferred growth.
- Potentially lower fees compared to some IRAs, depending on the plan.
- May allow for continued investment in certain institutional funds.
- Cons:
- Less control over your account.
- May forget about the account over time.
- Limited investment options compared to an IRA.
- No new contributions are allowed.
2. Roll It Over into an Individual Retirement Account (IRA)
A popular choice is to roll over your funds into an IRA, giving you more control and often a wider range of investment choices. This can be done with a Traditional IRA or, if you meet income requirements and pay taxes on the rollover amount, a Roth IRA. A direct rollover from your 401(k) to an IRA is generally the safest way to avoid taxes and penalties.
- Pros:
- Wider Investment Selection: Access to a vast array of stocks, bonds, mutual funds, and exchange-traded funds (ETFs).
- Consolidation: Simplifies your financial life by consolidating multiple old 401(k)s into one account.
- Flexibility: Greater control over fees and investment strategies.
- Cons:
- Requires active management and decision-making on your part.
- Potentially higher fees depending on the IRA provider and investment choices.
To learn more about managing your 401(k) when leaving a job, you can find additional insights at Fidelity Investments' learning center: What happens to your 401(k) when you leave a job?
3. Roll It Over into Your New Employer's Plan
If your new employer offers a retirement plan, such as a 401(k), you may be able to roll your previous plan's funds directly into it. This option helps keep all your retirement savings in one place, simplifying management.
- Pros:
- Consolidation: All your retirement savings are in a single account, making it easier to track.
- Continued Contributions: You can continue to contribute to this same plan.
- May offer benefits like higher contribution limits or loan options, depending on the plan.
- Cons:
- Investment options are limited to what the new employer's plan offers.
- The new plan's fees or performance may not be as favorable as your old plan or an IRA.
- Not all employer plans accept rollovers from previous plans.
4. Cash It Out
While an option, cashing out your retirement funds is generally not recommended due to significant financial drawbacks. When you cash out, you receive the money directly, but it's typically subject to immediate taxes and potential penalties.
- Pros:
- Immediate access to funds.
- Cons:
- Tax Implications: The entire amount is typically treated as taxable income in the year you receive it, potentially pushing you into a higher tax bracket.
- Early Withdrawal Penalty: If you are under age 59½, you'll likely face a 10% early withdrawal penalty from the IRS, in addition to income taxes.
- Loss of Future Growth: You lose the significant advantage of long-term tax-deferred compounding, which can severely diminish your retirement savings potential. For example, cashing out $10,000 today could mean missing out on tens or even hundreds of thousands of dollars in growth by retirement.
- Mandatory Withholding: The plan administrator is usually required to withhold 20% of your distribution for federal income taxes.
Summary of Options
Here's a quick overview of the implications for each choice:
| Option | Tax Impact | Penalty (if < 59½) | Control/Flexibility | Long-Term Impact |
|---|---|---|---|---|
| Leave with Previous Employer | None (continues tax-deferred) | None | Low (limited options, no new contributions) | Continued growth, but potentially overlooked |
| Roll into an IRA | None (if direct rollover) | None | High (wide investment choices) | Optimized growth potential, consolidated accounts |
| Roll into New Employer's Plan | None (if direct rollover) | None | Medium (tied to new plan's options) | Consolidated savings, continued contributions |
| Cash It Out | Full amount taxable as ordinary income | 10% IRS penalty + state taxes | High (immediate access to funds) | Severely diminished retirement savings potential |
Understanding these options and their implications is crucial for making an informed decision that aligns with your financial goals for retirement. It's often beneficial to consult with a financial advisor to determine the best path for your specific situation.
