Every employee has to make a significant retirement decision when leaving an employer. You have to decide whether to leave your 401(k) balance in the employer’s plan or move it somewhere else as you go.
It’s a decision you have to make whether you are changing jobs or retiring. You must think it through carefully; otherwise, you may disrupt your retirement investment and end up paying unnecessary taxes.
Research by Vanguard shows that nearly two-thirds of 401(k) account owners leave their funds with their former employer’s plan when leaving the job. However, just because most people do it doesn’t make it the right move.
You’ll have various choices, depending on your situation. Some of those actions may attract tax consequences if you fail to make a decision quickly enough. So it’s important to start researching your options as soon as you know you’ll be leaving your employer. Also, consider reviewing your choices with a financial advisor to give you a broader perspective.
This article expands on why taking the funds in your 401(k) balance as you leave an employer is the best move.
Can you leave your money in your previous employer’s plan?
The answer to the possibility of leaving your funds in a former employer’s 401(k) plan depends on the rules the employer set up for the plan and the size of your balance. For instance, if your balance is less than $5,000, the employer may be able to force you to take your funds out of the plan as you leave.
If your 401(k) balance is less than $1,000
In this case, the employer can cut you a check for the amount. It’s up to you to take action to avoid attracting taxes for the money.
If your 401(k) balance is between $1,000 to $5,000
In this case, the employer can roll the money into an IRA rollover account on your behalf. This will help you avoid tax consequences. But unless you take prompt action, the choice of IRA will be up to the former employer rather than yours.
If your 401(k) balance is $5,000 or above
If you have above $5,000 in your balance, you should be able to keep the funds in your former employer’s plan. However, there may be a few hitches on the way.
- If your balance later drops below $5,000 due to market fluctuations, the plan sponsor may decide to oust you from the plan. There’s the danger of being pushed out of the plan if your balance is slightly above $5,000 when you are leaving the employer.
- Any balances rolled over from previous employers are omitted when calculating these limits. For instance, if you have a $7,000 balance, and $4,000 of it was rolled over from a previous employer’s plan, then you’ve only accumulated $3,000 in your current plan. This leaves you vulnerable to be pushed out of the plan.
The bottom line is that you have to make a decision about your 401(k) balance when leaving an employer. Even when you are in a position to remain in the plan, there may still be better options for you out there, so it’s always best to research and consider each decision’s tax consequence.
