Most people think their 401(k) is theirs and that's all there is to it, but the reality is a little more complicated than that. The money is yours, but the plan belongs to your employer, and both of you have to abide by the federal government's rules for 401(k) accounts.
This can make some 401(k) decisions a little complicated, including what happens with your funds after you leave the company. If you have less than $7,000 in your balance at the time, you may want to take swift action to keep your money under your control. Here's what you need to know.
Image source: Getty Images.
What happens to your 401(k) balance after you leave your job?
What happens with your 401(k) when you part ways with your employer depends on your choices and your account balance.
Those who have at least $7,000 in their plans can leave their money alone, or they can roll it over to a new IRA or 401(k) if they choose.
In this scenario, employers aren't allowed to touch the money you already have in the plan. But you will not be able to put any more cash into this account. You could also lose money over time if the 401(k) charges high fees, so this is something to weigh when deciding whether to move your money.
If your 401(k) balance is between $1,000 and $7,000 when you split from your employer, your company could transfer your funds to an IRA in your name. Employers are legally allowed to do this without your permission, though that doesn't mean they will. If this happens to you, your 401(k) plan administrator will notify you of the move and provide instructions on how you can access your funds.
You might be fine with this, but it's important not to be too hands-off. Review your new IRA's fees and investment options to be sure you're putting that money to work for you in the best way possible. Index funds are always a great option if you don't know what to invest in.
Meanwhile, employers have the right to cash out former employees' 401(k) plans if their balance is under $1,000. If they do this, they'll cut you a check for the amount, minus 20%, which is automatically withheld for taxes. But this isn't money you can spend freely.
The IRS considers this check a distribution unless you deposit the full amount -- including the 20% that your 401(k) plan administrator withheld -- into a new retirement account within 60 days. Fail to do this, and you'll owe taxes on these funds if they came from a traditional 401(k), plus a 10% early withdrawal penalty if you're under 59 1/2 at the time.
How can you prevent your employer from closing your old 401(k) plan?
If your old 401(k) balance is under $7,000 or falls under $7,000 at any point, your employer has the right to move that money out of its plan if it wants to. But you can prevent this by moving your money to a new IRA or 401(k) first.
There are two ways to do this: indirect and direct rollovers. Indirect rollovers are where you cash out your plan and must redeposit the funds in a new retirement account within 60 days, as discussed. This usually isn't your best move.
Instead, opt for a direct rollover. This is where you tell your old 401(k) provider where you'd like the money sent, and it handles the transfer for you. There's no danger of owing taxes then, although the plan administrator may withhold a small sum for a rollover fee.
To do a direct rollover, you'll need an account to move the money into. This could be your new 401(k) if your new employer permits this. Or, an IRA might be a better fit if you want more control over how you invest your savings. Rollovers don't count toward your annual contribution limits for the year, so you can move all your cash at once and still save extra if you've got the funds on hand.
If you have any questions about what happens to your 401(k) plan after you leave your job, it's best to contact your plan administrator. Or if you'd rather be on the safe side, move your money within a few weeks or months of leaving before your employer gets a chance.
