Don’t forget about your old 401(k) if you quit a job or are laid off. What departing workers need to know

Whether you’re leaving your job by choice or not, don’t forget about your 401(k) plan. As workers continue quitting their jobs at an elevated rate and some companies embark on layoffs — including Amazon, Salesforce and Goldman Sachs — there’s a good chance some departing workers will be leaving an employer-sponsored retirement plan behind. While not everyone has a 401(k) or similar workplace retirement plan, those who do may want to be familiar with what happens to their account when they leave a job and what the options are — and aren’t.

You have three basic choices for an old 401(k)

Broadly speaking, you have several options for your old 401(k). You may be able toleave it where it is, roll it into your new workplace plan or an individual retirement account, or cash it out — although experts generally caution against the third move. Cashing out “is the least desirable option,” said Eric Amzalag, a certified financial planner and owner of Peak Financial Planning in Canoga Park, California. For starters, he said, you’d face paying taxes on the distribution — unless it’s post-tax money you put in a Roth 401(k). With some exceptions, you’ll typically also pay a 10% tax penalty if you’re younger than age 59½, which is when withdrawals from 401(k)s and other retirement accounts can begin. “If the account size is large, it could push the individual into a high tax bracket, causing the funds to be taxed at a higher and disadvantageous rate,” Amzalag said.

Keep track of money left in a former employer’s 401(k)

Perhaps the easiest thing you can do is leave your retirement savings in your former employer’s plan, if it’s permitted. Of course, you can no longer contribute to the plan. Nor will you be able to take a loan from that account as you can when you’re an active employee in the 401(k). However, while this might be the easiest immediate choice if it’s available, it could lead to more work in the future. Basically, finding old 401(k) accounts can be tricky if you lose track of them. While congressional legislation known as Secure 2.0, enacted in December, includes a provision for a retirement account “lost and found,” the Labor Department gets two years to create it. Some large 401(k) plan administrators — Fidelity Investments, Vanguard Group and Alight Solutions — also have teamed up to offer their own lost and found. Also be aware that if your account is small enough, you may not be able to keep it at your ex-employer even if you want to. If the balance is between $1,000 and $5,000, your ex-employer can roll over the amount to an IRA. (Secure 2.0 changed that upper limit to $7,000, effective for distributions made after 2023.) If the balance is less than $1,000, the plan can cash you out — which can lead to a tax bill and an early-withdrawal penalty.

Consider a rollover to a new workplace plan or an IRA

Another option is to transfer the balance to another qualified retirement plan, such as the 401(k) at your new employer, assuming the plan allows it. “The main advantage of this option is consolidation of your accounts and less to keep track of,” said CFP  Justin Rucci, an advisor with Warren Street Wealth Advisors in Tustin, California. You also could roll it over to an IRA, which may provide more investment choices — but also may come with higher fees, which can eat away at your nest egg. Be aware that if you have a Roth 401(k), it can only be transferred to another Roth account. This type of 401(k) and IRA involves after-tax contributions, which means you don’t get a tax break up front as you do with traditional 401(k) plans and IRAs. However, the Roth money grows tax-free and is untaxed when you make qualified withdrawals down the road.

Watch out for 401(k) ‘exit costs’

No matter what you choose to do with your old workplace retirement account, be aware of some of the potential “exit costs” related to it. For example, while any money you put in your 401(k) is always yours, the same can’t be said of employer contributions. Vesting schedules — the length of time you must stay at a company for its matching contributions to be 100% yours — range from immediately to up to six years. Any unvested amounts generally are forfeited when you leave your company. Also, if you have taken a loan from your 401(k) and haven’t repaid it when you leave your company, there’s a good chance your plan will require you to repay the remaining balance fairly quickly. Otherwise, your account balance will be reduced by the amount owed — called a “loan offset” — and considered a distribution. In simple terms, unless you are able to come up with that amount and put it in a qualifying retirement account by the following year’s tax-return deadline, it is considered a distribution that may be taxable. And, if you are under age 59½ when you leave the job, you may pay a 10% early-withdrawal penalty. About a third of employer plans allow former employees to continue paying the loan after they leave the company, according to Vanguard. This makes it worthwhile to check your plan’s policy.

There may be reasons to avoid an IRA rollover

It’s worth talking to a financial advisor before moving your old 401(k). In addition to portfolio considerations such as investment choices and fees, there may be planning consequences. For example, there’s something called the Rule of 55: If you leave your job in or after the year you turn age 55, you can take penalty-free distributions from your current 401(k). If you move the money to an IRA, you generally lose the ability to tap the money before age 59½ without paying a penalty. Additionally, if you are the spouse of someone who plans to roll over their 401(k) balance to an IRA, be aware that you would lose the right to be the sole heir to that money. With the workplace plan, the beneficiary must be you, the spouse, unless you sign a waiver allowing it to be someone else. Once the money lands in the rollover IRA, the account owner can name anyone a beneficiary without their spouse’s consent.