Should You Stay in Your Employer’s Retirement Plan After You Retire?

See options for your retirement savings when retiring or semi-retiring, including leaving money at a former employer's retirement plan or rolling into a new retirement plan.
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Any time you leave an employer, it forces you to make a key retirement planning decision: Should you leave your 401(k) balance in your prior employer’s plan or move it somewhere else when you leave?

You have a few different options, depending on your situation. In some cases, there could be tax consequences if you don’t make a decision quickly enough.

As soon as you know you may be leaving an employer, you should either research the possibilities yourself or review them with a financial advisor.

Can You Leave Money in a Former Employer’s Retirement Plan?

The first question is whether you have the option to leave money in a former employer’s retirement plan. The answer depends on the rules of that plan and the size of your 401(k) account balance:

If you have less than $5,000 in a 401(k) plan, your former employer may be able to force you to leave the plan when you leave the company. This depends on the rules that employer has set up for the plan.

Less Than $1,000 in a 401(k) Plan

If you have less than $1,000 in the plan, the employer can simply cut you a check for the balance. This leaves you responsible for taking action to avoid tax consequences for that money. Those consequences are explained in the next section of this article.

Between $1,000 and $5,000 in a 401(k) Plan

If you have more than $1,000 but less than $5,000 in the plan, the employer can roll the money over into an IRA rollover on your behalf. This avoids the tax consequences, but the choice of that IRA will be the former employer’s rather than yours unless you take action first.

More Than $5,000 in a 401(k) Plan

If you have accumulated more than $5,000 in the plan, you should be able to keep your money in your existing plan after you leave the employer. However, there are a couple of wrinkles to this:

If your plan balance later drops below $5,000 due to market fluctuations, the plan sponsor may be able to force you out in the future. So, if your balance is only slightly above $5,000 when you leave the company, you are in danger of being forced out of the 401(k) at some point.

Balances you rolled into the plan from a previous employer don’t count toward these limits. So, if you have an $8,000 plan balance but $5,000 of that was rolled in from a previous employer’s plan, you only count as having accumulated $3,000 in the current plan. This may leave you open to being forced out of the plan if you leave that employer.

The bottom line is that in some cases you may be forced to make a decision about what to do with an existing 401(k) balance when you leave your employer. Even in cases when you have the right to remain in the plan, there may still be better options for you.

IMPORTANT NOTE: This may be a time-sensitive decision in order for you to avoid tax consequences due to 401(k) withdrawal rules.

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What to Know About 401(k) Withdrawal Rules

It’s your age at the time you make a withdrawal that determines how 401(k) withdrawal rules will apply to your situation – in particular, age 59 1/2 and age 72.

401(k) Withdrawal Rules After 59 1/2

When it comes to taking money out of a 401(k) plan, 59 1/2 is a magic number. That’s the age at which 401(k) distributions are no longer subject to a 10% tax penalty.

The rules pertaining to 401(k) withdrawals after 59 1/2 still generally involve some tax consequences. Unless you are in a Roth 401(k) option, your 401(k) distribution will be subject to ordinary income taxes. Just 15% of 401(k) participants use Roth options, according to Vanguard.

Not only are traditional 401(k) distributions taxed, but, by being included in your income, they may bump you into a higher tax bracket. That’s why it’s wise to spread 401(k) distributions out over time rather than to take too much out in one year.

All of the above tax consequences can be avoided if money from a 401(k) is rolled into another tax-deferred plan, such as a 401(k) at a new employer or an IRA. You have 60 days after receiving a distribution from a plan to roll it into a new retirement plan to avoid these tax consequences.

If you are under age 59 1/2, there will almost certainly be tax consequences from taking money out of a 401(k) unless you roll it into a new retirement plan.

If you are 59 1/2 or older, there may still be some tax consequences.

These tax consequences are the reason you should take charge of what happens to your 401(k) account when you leave your employer.

401(k) Withdrawal Rules After 72

The other key age for retirement plans is 72. You can leave money in a retirement plan until you reach that age. At that point, you have to gradually start taking money out in the form of required minimum distributions. Even then you can leave most of your balance in the plan for years to come.

Being able to leave money in a retirement plan even after you retire is important because it allows you to continue to defer taxes on much of your savings during your retirement years.

Leaving Your Employer? Here Are Your Options

Here is a run-down of the choices you may have for your 401(k) balance when you leave your employer:

Leave Money in the Former Employer’s 401(k)

If your situation allows it, you can simply leave your balance in your prior employer’s 401(k) plan. However, you won’t be able to make new contributions to that plan, nor will you be eligible for any employer contributions to it.

Transfer Your Balance Into a New Employer’s Traditional 401(k)

Rolling a balance from a traditional 401(k) plan into a new employer’s traditional 401(k) allows you to avoid all tax consequences. Your subsequent 401(k) contributions will simply be added to the rolled-over balance in the new employer’s plan.

If you are fully retiring, this option won’t be on the table since you won’t have a new employer. However, people who are semi-retiring should be aware of this option.

Transfer Your Balance Into a New Employer’s Roth 401(k)

If your existing balance is in a Roth 401(k) option, it doesn’t make sense to roll it into a traditional 401(k) option. You will have already paid taxes on the money in a Roth option, which means your eventual distributions from it should be free of taxes.

If you are in a traditional 401(k) option at your old employer, you could roll that into a Roth 401(k) at your new employer. This would mean paying taxes on your existing 401(k) balance in this tax year. However, it would not be a considered a distribution subject to the 10% early withdrawal penalty.

Rolling over from a traditional to a Roth plan makes sense if your existing balance is relatively small and you expect your overall income in the year of the rollover to be relatively low. The combination of those two things should put you in a fairly low tax bracket that year.

However, if you do a traditional-to-Roth rollover, make sure you will have enough cash on hand to pay the income taxes on the rolled-over balance.

As with rolling your balance into a traditional 401(k) at a new employer, rolling into a Roth 401(k) is not a possibility if you are retiring fully. However, if you are shifting into semi-retirement with a new employer, it may be worth considering.

Roll Your Balance Over Into a Traditional IRA

From a tax standpoint, this would be the same as a rollover to a traditional 401(k)
as described above.

The only difference is that you would be responsible for finding your own investment options, rather than choosing from the menu of a 401(k) plan.

This may be a good option if you are fully retiring and need a vehicle for managing your retirement savings in retirement.

Roll Your Balance Into a Roth IRA

From a tax standpoint, this would be the same as a rollover to a Roth 401(k), as described above.

The key difference is that you would be responsible for finding your own investment options, rather than choosing from the menu of a 401(k) plan. If you are fully retiring, this may be a good option for managing your savings through your retirement years.

Cash Out Your 401(k) Balance

You could take the distribution as cash, but this is likely to have tax consequences.

If you are under age 59 1/2, you would pay a 10% tax penalty in addition to any ordinary income tax due on the balance.

Consolidating 401(k) Account Balances: Pros and Cons

Whether it’s rolling into a new employer’s 401(k) or your own IRA, you have options for avoiding tax consequences from taking money out of an existing employer’s 401(k). So the question of whether to leave the money behind or take it with you really comes down to investment issues.

Moving the money into a new plan allows you to add new contributions to your previous balance. This also makes it easier to keep track of your retirement accounts.

Most importantly, having your retirement money all in one plan makes it easier to follow a consistent asset allocation strategy suited to your needs. Think of this as having all your money working toward the same goal as opposed to potentially following inconsistent investment approaches.

Even when you are retiring, remaining constructively invested through your retirement years is vital to keeping pace with inflation. Coordinating your investments in one retirement account can aid that investment effort.

The only reason for leaving a 401(k) balance with a previous employer for an extended period would be if you thought that employer’s plan was much better than the 401(k) plan at your new employer or an IRA you could start on your own. The investment options available and the overall cost would be factors in deciding that.

Deciding What to Do About Your 401(k) Balance? Key Questions to Ask

Based on all of the above, the following is a list of questions that might help you narrow down your choice of what to do about your 401(k) balance when you leave an employer:

Do you have the option of leaving money in your former employer’s plan?Check with the benefits office of the former employer to see if this choice is even on the table.

Are You Older Than Age 59 1/2?

This determines whether or not you would face an early withdrawal penalty if you took money out of the plan without rolling it into a new retirement plan.

Are You Currently Enrolled in a Traditional or a Roth 401(k) Account?

Generally speaking, you should roll into the same type of option in new retirement plan, unless you a prepared to pay taxes on the money now by rolling from a traditional to a Roth option.

Do You Expect to Join a New Employer at Some Point?

If you are fully retiring, a transfer to your own IRA may be your best option. However, if you think you will work part time or start a second career, it may be more convenient to leave your retirement balance in your existing plan until you figure out what your next move is.

Does Your New Employer Have a 401(k) Plan?

If not, the best course might be to roll the money over into an IRA.

Does Your New Employer’s 401(k) Plan Have a Roth Option?

Not all 401(k)s have Roth options. If you’ve been in a Roth 401(k) but your new employer does not have that option, you may have to roll the money into a Roth IRA unless you can keep it in the existing plan.

Planning Changes to Your 401(k) Retirement Account

Your decision may be time-sensitive because, if you take a distribution from your existing plan, you have 60 days to roll it into a new qualified plan. Otherwise, you would face tax consequences.

It’s best not to rush this kind of decision. So, as soon as you think you might be leaving your employer, you should start looking into your options. That’s important whether you are fully retiring, semi-retiring, or simply changing jobs.

Weighing your options as soon as you know you will be making a change will give you time to do your research and work with a financial advisor toward the best outcome.

How to Invest in 401(k) When You’re Only a Few Years Away from Retirement

Investing is often about striking a balance. That balance includes working out the trade-off between near-term and long-term needs, as well as understanding how your 401(k) money can complement your social security benefits.

Here’s what you should take into account in striking the right balance:

Time Horizon

You might assume that being a few years from retirement equates to a fairly short investment horizon. However, your actual time horizon is probably closer to 25 years than two years.

You will need to invest for your probable life span, and that is long enough for inflation to significantly erode the value of your holdings if you don’t retain a growth element to your portfolio. Therefore a blended stock and bond portfolio is probably more appropriate for you than shifting completely to stable income investments.

Note that, even if you leave your company’s 401(k) plan when you retire, you can roll the money over into an IRA. Traditional IRAs allow you to maintain similar tax treatment to a 401(k) and thus delay the point where you have to pay taxes on your retirement savings.

Withdrawal Rate

One thing that impacts your time horizon is how quickly you withdraw money from your retirement plan. Try to draw down your retirement assets at a slow enough pace for them to last at least as long as your likely lifespan. If you need to draw down those savings more quickly, it effectively shortens your investment time horizon and that means you should be more conservatively invested.

Be advised that if you withdraw a fixed dollar amount every year, as your savings draw down, that dollar amount will become a progressively larger percentage of the remainder. That means that the pace of depletion will accelerate. This is another reason to try to limit how much you take out every year.

Note that, even if you reach a point where you have to make the required minimum distributions from your retirement plan, you don’t have to spend all of those distributions as you take them. You can keep the money invested in an after-tax investment portfolio, perhaps setting it up in CDs structured to provide you with liquidity to live off at regular intervals.

Social Security Strategy

If social security is able to meet a meaningful portion of your post-retirement expenses, then it effectively behaves like an income-producing investment and allows you to invest your other retirement savings a little more aggressively.

However, if you retire at 62, you will have to decide whether to settle for smaller social security payments by beginning to draw them at that point or to delay taking social security in favor of larger payments down the road. You should make this decision before deciding how to adjust your 401(k) investments. If you decide to delay taking social security, it could mean drawing more heavily on your retirement plan savings in the interim, suggesting a more conservative stock/bond blend is appropriate.

Richard Barrington, a Senior Financial Analyst at MoneyRates, brings over three decades of financial services expertise to the table. His insightful analyses and commentary have made him a sought-after voice in media, with appearances on Fox Business News, NPR, and quotes in major publications like The Wall Street Journal and The New York Times. His proficiency is further solidified by the prestigious Chartered Financial Analyst (CFA) designation, highlighting Richard’s depth of knowledge and commitment to financial excellence.
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