According to our friends at Investopedia, you essentially have four options when you leave your job and its accompanying 401K benefits:
No. 1: Withdraw the Money
This is a bad idea unless you urgently need the cash. The money will be taxable in the year it’s withdrawn, and you will be hit with the additional 10 percent early distribution tax unless you are over 59½, permanently disabled, or meet the other IRS criteria for an exception to the rule. (That said, this rule has been suspended for 2020 for those affected by the 2020 COVID-19 economic crisis.)
In the case of Roth IRAs, your contributions (but not any profits) may be withdrawn tax-free and without penalty at any time as long as you have had the account for at least five years. Remember, you’re still diminishing your retirement savings, which you may regret later.
No. 2: Roll Your 401K into an IRA
By moving the money into an IRA at a brokerage firm, a mutual fund company, or a bank, you can avoid immediate taxes and maintain the account’s tax-advantaged status. What’s more, you will be able to choose among a wider range of investment choices than with their employer’s plan.
The IRS has relatively strict rules on rollovers and how they need to be accomplished, and running afoul of them is costly. Typically, the financial institution that is in line to receive the money will be more than happy to help with the process and avoid any missteps.
Important to note: Funds withdrawn from your 401K must be rolled over to another retirement account within 60 days to avoid taxes and penalties.
No. 3: Leave Your 401K with the Old Employer
In many cases, employers will permit a departing employee to keep a 401K account in their old plan indefinitely, although the employee can’t make any further contributions to it. This generally applies to accounts worth at least $5,000. In the case of smaller accounts, the employer may give the employee no choice but to move the money elsewhere.
Leaving 401K money where it is can make sense if the old employer’s plan is well managed, and you are satisfied with the investment choices it offers. The danger is that employees who change jobs over the course of their careers can leave a trail of old 401K plans and may forget about one or more of them. Your heirs might also be unaware of the existence of the accounts.
No. 4: Move Your 401K to a New Employer
You can usually move your 401K balance to your new employer’s plan. As with an IRA rollover, this maintains the account’s tax-deferred status and avoids immediate taxes.
It could be a wise move if you aren’t comfortable with making the investment decisions involved in managing a rollover IRA and would rather leave some of that work to the new plan’s administrator.