I’m a millennial and rightfully described as a job-hopper. I’ve had 3 separate 401(k) plans to deal with in the past 7 years. I’ve screwed two up and learned a ton, so third time’s the charm right?! I’m here to break down that age old question of what happens to that 401(k) money after you leave your job and what do you do with it?
In all reality there are multiple routes you can take, but I can relate to all of them so get excited.
But first let’s break a couple things down:
What is a 401(k)/403(b) and why does everyone love them?
First of all, you might’ve noticed I lumped 401(k)s with 403(b)s and you deserve to know that they are essentially the same thing (from different types of employers). A 401(k) is offered by the typical run-of-the-mill company and a 403(b) is offered by your government agencies and the like. But what they are is an Employer-Sponsored “Retirement Account.”
That’s in quotations because that description comes with some pretty sweet perks (and some pretty strict rules).
Retirement accounts are tax advantaged savings accounts. Whether they are traditional (pre-tax) or Roth (post-tax) the money that goes into them removes your tax burden. Now or later.
Legally avoiding taxes is always awesome. Always. And because of that, most employers will contribute to your retirement accounts (they get to avoid those taxes that way, too).
A typical company will give you extra (read: FREE) money on top of your salary, but it’ll go into your retirement account.
A 401(k) has the highest contribution limits of all the tax-advantaged accounts. You can throw $19,500 a year in there, if you can spare it and let it grow until retirement.
How a 401(k) works: the dinner party
I figured out a 401(k) analogy so here goes:
Your company is hosting a dinner party at a fancy restaurant’s VIP room and because you’re an employee, you’re invited!
A 401(k) is the party. It’s invite only, either after a week, 90 days, or a year, that’s up to the host (your employer). And that party is held at a restaurant (a bank/broker-dealer). Now this restaurant sells food and there’s a menu, as is the typical restaurant business model, but if you host a party there then you are allowed to hand-pick the items offered on your party’s menu.
They even have a separate menu specifically for large VIP gatherings. It’s all packaged up pretty and easy for the guests. The smorgasbord has been consolidated down to a couple fool-proof, ultra desirable selections for you and your guests. Those meal selections are the different investments your employer decides to offer you through your 401(k)/at this party.
Now it’s a sweet deal! Everybody wins.
You get access to the party and the awesome food. Typically your boss will offer you money to spend there! It’ll sound something like “we will MATCH what you decide to pay at the party (up to 3% of your salary)”. Sometimes your employer will just give you money to spend at the party (this is called a Safe Harbor Investment). But if you really like the food, you can contribute up to $19,500 of your own money to your party tab.
Buy the food.
Your employer wins because the money they contribute to the party is tax deductible. Always cool. And the restaurant wins because they make a small profit for managing the party and preparing the food. The cost of them running it is a very small percentage of your contribution to the party because there’s so many VIPs and you guys make it easy for them.
Because you’re a VIP, everything is cheaper overall because there is less work required of the restaurant. Everything is already predetermined and you have fewer options.
So that’s what we’re working with. 401(k) is a dinner party that offers exclusive menu items (investments) and your employer helps you pay to show up and enjoy the all you can eat buffet (up to $19,500 plus any employer match). So now….
What happens to your 401(k) after you quit your job?
The current institution will be notified that you are no longer on the plan/VIP list. That money is still yours, so that’s cool, but you no longer get the benefits of being associated with your employer’s plan/party.
They’ll politely notify you of your options (via snail mail).
What can you do with your 401(k) money after leaving your job?
Once you receive word from your broker, the details will be written out in super small print or explained over a phone call with the broker (they’ll include the phone number). But considering phone calls are undesirable and you’re already here, this is the rundown.
1. Leave it where it is
This is the easiest option. The current broker (restaurant) will usually allow you to stay, but you will no longer be part of that 401(k) plan. You’re going to offered at a different menu.
Instead, you’ll be an individual investor. Suddenly you’re the guy who’s not on the list, so you’re standing outside the VIP room and getting charged for being in the way.
They can change the account type and adjust the fee schedule. Generally, it’s not worth the “simplicity”.
2. Rollover to your new 401(k) or 403(b)
Most people have a new job before they quit the old one, and that new employer will hopefully have a 401(k) for you to hop into.
If there’s a waiting period for that 401(k), then move on to the next alternative.
3. Rollover to an IRA
An IRA or Individual Retirement Account is typically self-directed meaning the restaurant you’re at is more like an open kitchen for you to use to cook your own food.
Luckily, they have the food there and you just have to pay for it. The great news is, all the money your employer gave you can probably go too. This is entirely dependent on your previous employer’s vesting schedule.
Quick side note:
What does vesting mean??
Before you even consider quitting, you should check out your company policy surrounding the 401(k) plan offered and take a good look at the vesting verbiage. Companies that contribute to your retirement will always have one.
It’s normal for a company to deduct a portion of their contribution if you quit within a certain timeframe (1-3 years). But some places will consider you 100% vested immediately (yay. we like this). Other times you might see something like “60% vested for the first 2 years” which means if you leave within the first two years then they will take 40% of what they “gave” you. 🥴
Once you are 100% vested, that money is yours to keep/rollover.
4. Cash out (minus an eventual tax penalty)
You can always take the money. It’s yours, after all, and after accounting for any funds which are not vested.
The thing about that is the penalty. You will be taxed on the contributions AND dinged with an additional 10% penalty when tax time comes.
You can, however, “cash out” and not pay a penalty IF you “rollover” those funds into an IRA within 30 days.
You’re current broker will send info about that!
How to move a 401(k) without being penalized
There is one penalty-free option for your former 401(k): roll it over
Moving that money with a “rollover” is a transfer. It’s a transfer with a different name which only applies to these retirement accounts.
You can rollover to a new 401(k)/403(b) or rollover to an IRA. But you have to do it within 30 days of cashing out. Or be taxed/penalized.
What should I do with my old 401(k)?
The only people you should listen to when it comes to what to do with your investments is yourself and/or a fiduciary financial advisor.
I (and most online resources) are not qualified to give you financial advice. This is strictly for your education and entertainment. I can share the facts and inform you of my opinions which includes this: do not take financial advice from anyone who does not know your specific position.
You know your money better than everyone, and because of that only you can make the right decision for you.
Having said that, I can give you some examples of “good” reasons to use each avenue listed above.
Leave it where it is
… when you don’t know which alternative to choose yet. Note the investment options provided and any fees (annual or otherwise) that you’ll be incurring.
Chances are you can find something free somewhere else. I would move to somewhere free before any fees come out, unless….
Rollover to your new 401(k)
… when you already have a new job and they will immediately open a 401(k) for you. Since some employers will have you wait 90-days or more, this isn’t always an option. But it’s a very good option.
You’re essentially taking everything you have and moving it to the new party lol. It’s nice to have retirement funds all in one place.
Rollover to an IRA
… if you already have one open or your new job doesn’t have a plan available to you and your current institution isn’t a good deal.
This is an awesome option that will allow you to invest the money as you see fit. That can be intimidating for some people, and this is where robo advising comes in handy.
Investing in low cost index funds is very common advice for good reason, but robo advisors can take the thinking out of it. I use Wealthfront and love them.
… when you really need some cash (not a great idea) or when you can’t do a direct rollover and instead need to deposit funds directly from your bank account. If you cash out and don’t deposit/rollover into a qualified retirement account (another 401(k) or IRA) then you will be taxed an extra 10% penalty at the end of the year. 😐
It’s a mess. As I mentioned earlier, you can cash out AND avoid the tax penalty if you get that money into the right account within 30 days.
Your 401(k) is yours, and deserves a safe place in your portfolio
After all is said and done, your 401(k) is part of your retirement savings/nest egg. Since you’ve made it this far, you’re clearly interested in taking good care of it. The best next step you can take is to get incredibly comfortable understanding where it is (the restaurant) and what how much is invested in what (your meal and the size of your plate!).