What Happens to Your 401(k) When You Switch Jobs?

According to the Bureau of Labor Statistics, baby boomers held an average of 12.4 jobs between the ages of 18 and 54. It’s fair to assume members of Generations X, Y and Z will average as many if not more jobs in the same years given how the workplace has changed. Pensions that were prevalent decades ago are now practically extinct, as are any one-company careers they once made worthwhile.

Today, employers are far more likely to offer a 401(k) plan than a pension. So, what happens to your 401(k) account when you leave a job? You have four financially wise options to consider and one not-so-wise option unless it’s absolutely necessary.

1. Keep it with your former employer.

Fortunately, you don’t have to make a decision right away. Unless your 401(k) is worth less than $5,000 ($7,000 starting in 2024), most plans allow you to keep it with your former employer. This gives you time to compare and contrast all your options to find the best choice for your financial situation.

Long term, answering some key questions will tell you if it makes sense to leave your 401(k) where it is:

• How many and what kind of mutual funds can you invest in through the plan?
• Will those investment vehicles help you reach your retirement goals?
• How high are the plan’s fees?

Many people move their 401(k)s for the following reasons:

• For more investment choices and lower fees
• To consolidate financial accounts, making it easier to track the total amount of retirement savings and maintain an age- and risk-appropriate balance between stocks, bonds and cash
• Because contributions to it are no longer allowed

2. “Direct transfer” it to a new employer’s 401(k) plan.

You can also take your old 401(k) with you to your new employer, assuming a few things:

• It sponsors a 401(k) plan.
• That plan accepts rollovers.
• You like the investment options and are okay with the plan’s fees.

You also need to participate in your new employer’s plan for this option to work. Sometimes, there is a waiting period before you’re eligible. In that case, leave your old 401(k) where it is until you’re able to open your new 401(k).

Once opened, let the new plan administrator know that you want to rollover your old account into your new one. Request this as a direct transfer, which means you won’t incur any penalties or taxes. The administrator will tell you what you need to do next, which will include contacting the old plan’s administrator.

In many cases, the two plan administrators can manage the entire process electronically in a direct trustee-to-trustee transfer. Otherwise, the old plan administrator sends a check made out as directed by the new plan administrator. Ideally, this check is sent directly to the new administrator. However, some plans require that the check be sent directly to you. You’re then responsible for delivering it to the new plan administrator.

3. Roll it over into a traditional IRA.

Another place to move your old 401(k) is to an IRA because these tax-advantaged retirement accounts often have more investment options and lower fees than 401(k) plans. There are two types of IRA: traditional and Roth. The biggest difference between them is when you benefit from the tax advantage.

With a traditional IRA, you can deduct all or part of your annual contributions from your tax return up to certain income limits. But when you withdraw money from this type of IRA in retirement, it’s taxed as ordinary income. You’re also subject to required mandatory distributions (RMDs) starting at a certain age (73 in 2023, going to 75 in 2033).

If you already have a traditional IRA, you can rollover your old 401(k) by instructing its plan administrator to complete the transaction, making sure to request it as a direct transfer. They will let you know what information or documentation is needed to handle your request. In this case, you’re not allowed to ever move these funds into another 401(k) in the future.

To gain that flexibility, you need to open a new traditional IRA designated as a rollover IRA, and then follow the steps above for contacting your 401(k)-plan administrator.

Going forward you can make annual contributions to your traditional IRA up to the amount the IRS allows. As of 2023, that limit is $6,500 if you’re younger than 50 and $7,500 if you’re 50 or older.

4. Convert it to a Roth IRA.

With Roth IRAs, you can’t deduct annual contributions. Instead, you get the tax advantage in retirement because your withdrawals are not taxed as long as you’re 59 and a half. This is an important distinction when deciding what to do with your old 401(k) because unless it is designated as a Roth 401(k)—an option that some employers now offer, you have to pay taxes on any funds rolled over into a Roth IRA when you file your next tax return.

You can minimize this immediate tax consequence and still get the Roth retirement tax advantage by rolling over your 401(k) into a traditional IRA, and then incrementally converting its funds into a Roth IRA over time.

To initiate a 401(k) rollover into a Roth IRA, follow the same steps as for a traditional IRA, including the request that it be a direct transfer.

There are a few other things to know about Roth IRAs before you make your decision. Your income determines how much, if anything, you can contribute to it in future years. However, you don’t have to worry about required mandatory distributions (RMDs) as you age.

A tax professional can help you determine whether a traditional or Roth IRA makes the most sense for your 401(k) rollover. But in general, experts say that a traditional IRA works best when you expect a lower tax bracket in retirement than non-retirement. On the other hand, a Roth IRA makes sense when you anticipate a higher tax bracket in retirement than non-retirement.

5. Understand the consequences of your final option.

Your final option is cashing out your 401(k). If you do this before you’re 55, you’ll have to pay a 10% penalty on top of the taxes generated by the withdrawal. Unless you absolutely need the money for a critical purpose, you’re much better offer choosing one of your other options.