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What happens if you don’t roll over a 401k plan?

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Changing jobs involves making several key decisions. The most obvious is to take the new position. Another is whether to do a 401k rollover. You can roll it over to your new employer’s 401k plan or a traditional IRA or Roth IRA. A third choice is not to roll it over at all. You can cash it out or choose to leave it at your old employer. Let’s review the pros and cons of each of these.

Cashing out your 401k plan

When you change jobs, your financial circumstances may make cashing out your 401k plan an appealing option. The money is available for the taking, and you’ll have an opportunity to build your retirement savings again with your new employer. Your old employer may offer this as an option when you notify them about your job change.

Unfortunately, there’s a price to pay for cashing out your retirement savings. 401k plan are designed to accept contributions while you’re working and only distribute funds after you’ve retired. There’s a 10% early withdrawal penalty for taking them out early. You’ll also need to pay taxes on the full amount because your contributions were tax-deferred until withdrawal.   

Leaving your 401k with a former employer

Some 401(k) administrators will allow you to leave your 401k plan with your former employer in exchange for a management fee. This is an appealing option for employees switching to self-employment because they can keep their existing retirement savings and contribute up to $22,500 per year annually to increase their retirement nest egg.

If you don’t have a 401(k), self-employed individuals can open an individual retirement account (IRA). The IRS only allows annual contributions of $6,500 to an IRA, so retirement savings will build much slower. If you’re over 50, that maximum contribution amount goes to $7,500. If you retain your 401(k), you can still open an IRA, increasing your savings limits.    

401k rollover options

Cashing out your 401(k) will cost you roughly 1/3rd of your money. Leaving it with a former employer incurs management fees. Rolling it over is simpler. If your new employer offers a 401(k), the best option is to roll it over to them. If not, you may need to rollover to a traditional IRA or a Roth IRA. You’ll then be able to add to your account at the rate of $6,500 or $7,500 per year.

One potential drawback to rolling over a 401k plan to a new employer is any stock matches that may have been given to you by your old employer. Those generally have a vesting period. If the stock has not been vested, you may not be able to take those funds with you. Check with your plan administrator for more details so you know how much to expect in the rollover.

The Bottom Line

The urge to cash out your 401(k), especially if it only has a few thousand dollars in it, may be too strong to resist. It’s in your best interests to do a rollover instead or leave the funds under the care of your former employer if that’s an option. Cashing out will cost you a 10% early withdrawal penalty and will be taxed based on income. Rolling over into your new employer’s 401k plan or an IRA costs nothing and will allow you to continue saving.  

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