What Happens to Your 401(k) When You Leave a Job? Your Options and How to Make the Best Choice

Across the US, 75% of workers have access to employer retirement benefits. 401(k)s are among the most common plans available.

Since a 401(k) retirement account is tied to a specific employer, you may wonder, What happens to my 401(k) when I leave a job?  We asked David Blanchett, PhD, CFA, CFP, head of retirement research at Prudential and a portfolio manager at PGIM, what options people have when they switch jobs…and what key considerations they should take into account to ensure they’re not losing out.

What Happens to Your 401(k) When You Leave a Job?

When you leave a job, a 401(k) generally follows one of three paths based on IRS regulations and your account balance…

When the amount in the 401(k) is less than $1,000, most employers will automatically cash out your 401(k) balance and cut you a check. The IRS does not require your employer to automatically roll over your balance. This money is then taxable and subject to an early withdrawal penalty.

When the amount is between $1,000 and $7,000, your employer is not required to keep your funds in its plan, but it is required to automatically roll the balance over to an individual retirement account (IRA).

When the amount is over $7,000, your employer must keep your funds in its plan unless you provide instructions for a rollover or distribution.

Understanding 401(k) Vesting Rules

“Your money and your contributions are always 100% vested,” says Blanchett. “No matter how long you’ve been at a company, all the money that you contributed to the 401(k) is yours when you leave that job.”

But if your employer matched the funds you contributed to your 401(k)—as many do—you aren’t necessarily entitled to all of the money your employer has matched. In many workplace plans, employees receive ownership of the employer’s contributed money over time. This is called vesting. For the employer’s contributions, explains Blanchett, 401(k) vesting rules and schedules dictate how much you are entitled to…and when. These rules can vary significantly by company…

Immediate vesting: Employees are entitled to all of their employer’s contributions starting day one of employment.

Graded vesting: Employees gradually receive ownership of their employer’s contributions. Example: 20% each year for five years of employment. After five years, all the employer’s contributions would be fully vested.

Cliff vesting: Employees receive full ownership after a set amount of time, such as three years.

“Find out what your company’s vesting schedule is before you decide to leave a job so you don’t lose out on a lot of money,” warns Blanchett. Example: If you were to decide to leave the company after two years and 11 months and the company has three-year cliff vesting, you could lose all the money contributed by your employer.

Your Options for a 401(k) After Leaving a Job

There is no one-size-fits-all answer on what to do with 401(k) accounts from past jobs. “It’s really situational based on the particular plan,” Blanchett says. Overall, there are four main options…

Leave the 401(k) with your former employer.

This is the simplest option if you have more than $7,000 in your 401(k). You can keep the same investments and let your old employer handle the administration of the account. This option is especially beneficial if your old employer’s 401(k) plan has particularly attractive pricing, which is common with major companies.

Roll over your 401(k) to your new employer’s plan

You can choose to roll the funds in your old employer’s 401(k) plan into your new job’s 401(k) if the plan allows it. This is a good option if you like the new employer’s 401(k) fees and investment choices…or for people who change jobs frequently because it reduces the risk that you will lose track of the account. Blanchett recommends against having five or six different 401(k) plans with former employers, if possible, because it can get unwieldy.

Roll over your 401(k) into an IRA

A 401(k)-to-IRA transfer generally is the easiest method and consolidates all your funds in one account. It allows you to choose your own investments while still maintaining the benefit of tax deferral. This may also be an attractive option if you are retiring soon, according to Blanchett, because it typically is easier to access retirement funds from an IRA than a 401(k) plan.

Cash out your 401(k)

Instead of rolling over a 401(k), you can cash it out after leaving a job. But if you’re younger than 59½, you’ll incur a penalty on the withdrawal and put a halt on the compound growth of that money. The amount withdrawn also is subject to tax.

Key Considerations Before Making a Decision

Taxes and penalties

If you don’t roll over a 401(k) or an IRA, you create a “taxable event.” If your employer cashes out your 401(k) at the time you leave the company…or you decide to cash it out yourself…any taxable portion of the distribution is subject to mandatory 20% withholding. And if you’re below retirement age, you’ll pay an additional 10% in 401(k) withdrawal penalties.  You may owe additional taxes based on your situation.

Fees and investment choice

Compare the plan fees for your old 401(k) to those for the new plan. “Employer perspectives on retaining employee balances differ dramatically,” says Blanchett. Companies sometimes charge employees who are no longer with the company higher fees than they do current employees.

Account balance thresholds

Unless you have more than $7,000 in your account, your employer is going to determine what happens with your 401(k), based on your balance, unless you take action.

Outstanding 401(k) loans

Dealing with a 401(k) loan after leaving a job complicates things. “If you have an outstanding loan on your account when you’re leaving an employer, it may have been on a five-year repayment schedule, but all of a sudden that balance will become due when you leave,” Blanchett said. You’ll have the chance to pay off the loan within a certain time frame…but if you don’t, the outstanding loan balance becomes a deemed distribution and you’ll have to pay income tax and early-withdrawal penalties on the amount.