If you leave a job, you'll be entitled to a distribution of the vested balance in your account. Your vested balance will always include your contributions (pretax or after-tax) and any growth or earnings on those amounts. It also includes your employer’s contributions that have satisfied your plan's vesting schedule.
This schedule will vary by employer so, it's important for you to understand how your particular plan's vesting schedule works. Your 401(k) Plan Document (available through your HR department) will spell out how the vesting schedule for your particular plan works. If you're on the cusp of vesting, it may make sense to wait a bit before leaving, if you have that luxury.
Should I roll over to my new employer's 401(k) plan or to an IRA?
When it comes to the decision of where to move your 401(K), there's no right or wrong answer to this question. You need to consider all of the factors, and make a decision based on your own needs and objectives.
Reasons to roll over to an IRA:
- When investing in an IRA, You generally have more investment choices than with an employer's 401(k) plan. You can freely move your money around to the various investments, including individual stocks and bonds along with mutual funds and you may divide up your balance among as many of those investments as you want. By contrast, 401(k) plans typically give you a limited menu of investments (usually mutual funds) from which to choose.
- You can easily transfer your IRA dollars among different IRA accounts. This gives you flexibility to change trustees often if you are dissatisfied with investment performance or customer service. With an employer's plan, you can't move the funds to a different trustee unless you leave your job and roll over the funds.
- An IRA may give you more flexibility with distributions. Your distribution options in a 401(k) plan depend on the terms of that particular plan, and your options may be limited. However, with an IRA, the timing and amount of distributions is generally at your discretion (until you reach age 70½ and must start taking required minimum distributions in the case of a traditional IRA).
- You can roll over (essentially "convert") your 401(k) plan distribution to a Roth IRA. You'll have to pay taxes on the amount you roll over (minus any after-tax contributions you've made), but any qualified distributions from the Roth IRA in the future will be tax free.
Reasons to roll over to your new employer's 401(k) plan:
- Most employer 401(k) plans have loan provisions. If you roll over your retirement funds to a new employer's plan, you may be able to borrow up to 50% of the amount you roll over if you need the money. You can't borrow from an IRA--you can only access the money in an IRA by taking a distribution, which may be subject to income tax and penalties. (You can, however, give yourself a short-term loan from an IRA by taking a distribution, and then rolling the dollars back to an IRA within 60 days.)
- A rollover to your new employer's 401(k) plan may provide greater creditor protection than a rollover to an IRA. Most 401(k) plans receive unlimited protection from your creditors under federal law. Your creditors (with certain exceptions) cannot attach your plan funds to satisfy any of your debts and obligations, regardless of whether you've declared bankruptcy. In contrast, any amounts you roll over to a traditional or Roth IRA are generally protected under federal law only if you declare bankruptcy. Any creditor protection your IRA may receive in cases outside of bankruptcy will generally depend on the laws of your particular state. If you are concerned about asset protection, be sure to seek the assistance of a qualified professional.
- You may be able to postpone required minimum distributions. For traditional IRAs, these distributions must begin by April 1 following the year you reach age 70½. However, if you work past that age and are still participating in your employer's 401(k) plan, you can delay your first distribution from that plan until April 1 following the year of your retirement. (You also must own no more than 5% of the company.)
- If your distribution includes Roth 401(k) contributions and earnings, you can roll those amounts over to either a Roth IRA or your new employer's Roth 401(k) plan (if it accepts rollovers). If you roll the funds over to a Roth IRA, the Roth IRA holding period will determine when you can begin receiving tax-free qualified distributions from the IRA. So if you're establishing a Roth IRA for the first time, your Roth 401(k) dollars will be subject to a brand new 5-year holding period. On the other hand, if you roll the dollars over to your new employer's Roth 401 (k) plan, your existing 5-year holding period will carry over to the new plan. This may enable you to receive tax-free qualified distributions sooner.
When evaluating whether to initiate a rollover always be sure to (1) ask about possible surrender charges that may be imposed by your employer plan, or new surrender charges that your IRA may impose, (2) compare investment fees and expenses charged by your IRA (and investment funds) with those charged by your employer plan (if any), and (3) understand any accumulated rights or guarantees that you may be giving up by transferring funds out of your employer plan.
What about outstanding plan loans?
In general, if you have an outstanding plan loan, you'll need to pay it back, or the outstanding balance will be taxed as if it had been distributed to you in cash. If you can't pay the loan back before you leave, you'll still have 60 days to roll over the amount that's been treated as a distribution to your IRA. Of course, you'll need to come up with the dollars from other sources.