Changing Jobs? What to Do With Your 401(k) So You Don't Leave Money On the Table

Quitting or changing jobs is a bit en vogue this season. 

Over the summer, 10.9 million job positions sat unfilled according to data from the Bureau of Labor Statistics (BLS). 

Meanwhile, millions of currently employed people are polishing up their LinkedIn pages and cruising job boards, hoping to find that perfect hybrid work-from-home position that doesn’t patrol their living rooms via webcam. Let’s also not forget the millions of Americans who weathered the grueling rough patches of unemployment last year—or maybe still are.

Needless to say, human resources departments are probably going bananas attempting to keep up with all the paperwork. And employees themselves have to keep up with their own checklist of stuff to do to make the job transition as smooth as possible.

One of the top items on that checklist is often what to do with your 401(k)—the historical gold standard for company retirement benefits. If you’ve ever had a full-time salary job with a private company, you probably had the chance to open a 401(k) through your company. Public institutions and nonprofit workers might have a 403(b) instead, but they function similarly. Your employer may have even offered to match your pre-tax contributions, perhaps up to 3% to 6% of your salary.

But when you leave that job, what do you do with all that cash sitting in your account? Let's take a look at your options.

Before you change jobs, make sure the email address and contact information listed in your investment management company’s account is accurate and up to date.

Be on the lookout for emails and letters from your employer and the financial company explaining what their process is. You usually have about 30 days from the day you leave a job to think about what you want to do with the money inside your 401(k).

You can just let your 401(k) linger, but what happens with it next depends on your company and the investment manager it uses. 

If you work for a major company with millions of assets under financial management, you might be able to keep your 401(k) exactly where it’s at without penalty. However, some employers only do this for accounts with balances over $5,000 or so. 

Check with your employer to see what the policy is for smaller accounts. If it’s to cut employees a paper check, you’ll have 60 days to deposit that check into a qualified retirement account before the IRS considers it an early withdrawal subject to full taxes and penalties.

There are two ways you can direct your 401(k) money into an IRA:

The default Safe Harbor IRA option

Sometimes, your investment manager will automatically roll over your company-sponsored 401(k) into an individual retirement account (IRA) under the same management. This safe harbor IRA protects you from early withdrawal penalties and preserves the tax-advantaged status of your money by creating a paper trail showing that the money never landed in your personal checking account. 

All you usually need to do is sign a few electronic forms saying you agree and establish new login credentials with the financial manager (independent of your old company login). This passive rollover option is fine if you can’t even look at your money due to feeling overwhelmed or a bumpy job transition. But you won’t have as much say over asset allocation, fees, etc. as you would when choosing your own IRA.

Choose your own IRA

Instead of going with whatever IRA your portfolio manager suggests, you can choose your own. This option allows you to determine your own asset allocation, shop around for the most competitive fees, and even transfer to a new asset manager. Do some research ahead of time, looking at both low-cost robo-advisors and bigger traditional firms. 

Robo-advisors Wealthfront and Betterment offer IRAs. Meanwhile, the online advisor Blooom will link to your existing 401(k)s and IRAs and offer free insight to help you understand what you want out of your retirement plan before you choose.

For the active investors who love to do the most, a self-directed IRA is your new best friend. Why? Unlike traditional retirement plans—where you simply choose your asset allocation and let the investment manager put your money into broad-sweeping funds—self-directed IRAs let you invest in just about any kind of investment you want. This can include sustainable farmland, real estate, precious metals, cryptocurrency, livestock, and more.

You can roll your 401(k) to a self-directed IRA in some cases, but not all. It depends on what your former employer’s policies are, whether your current 401(k) has money from other previous retirement accounts in it and whether the money is vested.

Finally, the option that makes your brain relax. Imagine all your old 401(k)s, consolidated into one account. No more random $2,000 retirement accounts floating in outer space. Roll over your previous employer’s 401(k), plus any others, into the retirement account at your new job. This option shouldn’t hit you with any fees or penalties, since it’s a clean transfer from one pre-tax retirement account to another. 

When you have a sizable amount of money sitting in your retirement account, the imagination loves to go on long monologues about what you could do if you were to cash out those investments and have that money in hand.

But here’s why that’s not a great idea: For starters, the IRS will hit you with an early withdrawal penalty (around 10%) for the money you use before age 59 ½. Secondly, you’ll have to pay full taxes on that money, since you never paid taxes on it to begin with. Adding another $50,000 of taxable income to your return is bound to fluster your accountant, at the very least—but it also sets you back investment-wise.

Even if you expect to make that money back again in a year or two, you're missing out on compound interest, which builds on returns as they grow. In other words, taking out $50,000 now and starting over from scratch will cost you more than you think, even if you're able to replace that $50,000 with the salary at your new job.

For example, let's say you cash out and then start your new job contributing $100 per week to a new 401(k). If you're getting average market returns of 10%, you'll have about $76,000 in 10 years. If you'd rolled that $50,000 over to your new 401(k) and continued contributing $100 per week, you'd have about $206,000 in 20 years. In addition to losing the $50,000 you cashed out, you've also lost out on about $80,000 of investment returns.

Bottom line? Consider cashing out a last-resort option, and only if you can justify the cost.