The 1 Thing You Should Never Do With Your 401(k) When You Leave a Job

When you leave a job for a new one, there are a host of tasks you typically have to deal with after the fact. You may need to update your health insurance information, sign new direct deposit forms, and plan for a whole new commute.

There's also your retirement savings to think about. If you had a 401(k) through your old employer, you'll need to figure out what to do with that money. But I'm here to tell you that almost any option is better than cashing out that 401(k) and taking the money.

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The problem with cashing out your 401(k)

You may be inclined to cash out your 401(k) when you leave a job. But depending on your age, that could be a costly move.

If you cash out a 401(k) before turning 59 and 1/2, you're generally subject to a 10% early withdrawal penalty, not to mention taxes on the sum you withdraw. Depending on your 401(k) balance, that 10% penalty could be quite substantial.

But also, when you cash out a 401(k), that money is no longer invested in a retirement plan. That means you could end up losing out on years of gains.

Imagine you cash out a 401(k) worth $10,000 at age 50. Not only will you face a penalty and taxes most likely, but if you're not retiring until age 65, it means missing out on 15 years of gains. At a 7% return, which is a few notches below the stock market's average, you're looking at retiring with almost $27,600 less when you account for lost growth on your $10,000.

Options for your 401(k) when you leave your job

If you're leaving your job, you may be able to keep your money in your current 401(k) plan. I don't recommend that, though.

If there are updates to your plan's rules or forms that need to come your way, your employer may not be so invested in making sure you get the right information if you're no longer on the payroll. And while the 401(k) plan administrator should be tasked with making sure you receive the appropriate notices, that doesn't always happen.

A better bet, in my book, is to roll your 401(k) into a new retirement plan. You could open an IRA and send the money there, or roll your balance into your new employer's 401(k) plan if there's one available to you.

No matter which option you choose, aim for a direct rollover. That way, your money lands in your new retirement account and you're not the one tasked with depositing it.

If you do an indirect rollover, you only have 60 days to get your money into your new retirement account. Mess that up, and your rollover could be treated as a distribution. That means the penalties and taxes we talked about earlier, which is just bad news.

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