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WalletPrep worksheet · Investing

What to do with your 401(k) when you leave a job

Name ____________________ Date __________

Key ideas

  1. You have four choices for an old 401(k). Leave it in the old plan, move it to your new plan, roll it into an IRA, or cash it out.
  2. A direct rollover has no tax withheld. The old plan sends the money straight to the new account. A check made out to you has 20% withheld.
  3. Cashing out early costs tax plus 10%. Before age 55 in the year you leave, a cash-out is usually taxed as income with a 10% additional tax on top.

Vocabulary

Rollover
Moving money from one retirement account to another, such as an old 401(k) to an IRA, without paying tax on it.
IRA
Individual retirement account: a tax-advantaged retirement account you open yourself at a bank or brokerage, separate from your job.
401(k)
A retirement savings plan offered through an employer. Money comes straight from your paycheck, often with an employer match.
Tax withholding
Income tax your employer takes out of each paycheck and sends to the IRS for you, as a prepayment of your yearly tax.
Stock
A small piece of ownership in a company. Its price rises and falls with how investors value the business.
Roth IRA
An IRA funded with money you already paid tax on. Growth and qualified withdrawals in retirement are tax-free.

Work it out

Priya is 31 and leaving her job with $18,000 in a traditional 401(k). She is in the 22% federal tax bracket and is tempted to cash out.

  1. 401(k) balance
  2. Income tax at 22%
  3. 10% additional tax
  4. Left after cashing out
  5. Rolled over at 7% for 30 years

Check yourself

  1. Your old plan mails you a check for a $10,000 rollover. How much will the check be for?

    • A. $10,000
    • B. $9,000
    • C. $8,000
    • D. $7,500

  2. Which move keeps your old 401(k) untaxed with nothing withheld?

    • A. A direct rollover to an IRA
    • B. A lump-sum cash withdrawal
    • C. A check made out to you
    • D. Closing the account

  3. You have Roth 401(k) money. Where should it go to stay tax-free?

    • A. A traditional IRA
    • B. A savings account
    • C. A Roth IRA
    • D. A taxable brokerage account

Your turn

Log in to any old 401(k) you have, or find your last statement. Write down the balance and the plan's phone number. If you have more than one old account, pick where they will all go and open that account.

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Answer key

What to do with your 401(k) when you leave a job

Work it out

  1. 401(k) balance$18,000
  2. Income tax at 22%− $3,960
  3. 10% additional tax− $1,800
  4. Left after cashing out= $12,240
  5. Rolled over at 7% for 30 years$146,097
  1. Cashing out adds $18,000 to her income. Tax at 22% is $18,000 × 22% = $3,960, and the 10% additional tax is $18,000 × 10% = $1,800.
  2. She keeps $18,000 − $3,960 − $1,800 = $12,240, before any state income tax. That is about 68% of the balance.
  3. With a direct rollover she keeps all $18,000 invested. At an assumed 7% a year, which is not promised, it could grow to about $146,097 by age 61.

Check yourself

  1. C. $8,000 A plan must withhold 20% when it pays you directly. $10,000 × 20% = $2,000 withheld, so the check is $8,000.
  2. A. A direct rollover to an IRA In a direct rollover the old plan pays the new account directly, so no tax is withheld and the move is not taxed.
  3. C. A Roth IRA Roth money belongs in a Roth IRA or another Roth account, so it keeps its tax-free treatment.