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Summary

If you have a 401K plan and leave your employer before reaching age 59 1/2, and you are not disabled as defined by the Internal Revenue Code:

  • The amount of money you can take depends on how much is vested
  • If you do not rollover the amount, you will have to pay income taxes and an early distribution penalty.

Amount You Can Take With You

The amount of money that you can take with you depends on whether the money in the 401K plan is vested (belongs to you). When money is vested, you own it and can take it with you no matter when you leave your employer.  On the other hand, if money is not vested, you cannot take it with you until you become fully vested. 

The amount you contribute and the earnings on that contribution are always vested 100%. You have a right to the money you contribute from the day you contribute it. This is also true with respect to the earnings on the money you contribute.

The amount of your employer's matching and profit sharing contributions that vests, and the time period over which vesting occurs, depends on what is specified in the plan. It is not unusual for assets to vest at a prescribed rate each year. For example, a plan may provide that 20% of the employer's contribution vests every year for 5 years. If you stay with the employer for 5 years, the entire amount of the contribution and earnings on that contribution vests. On the other hand, if you leave at the end of three years, you can only take 60% of the employer's contribution and 60% of the earnings on that contribution (20% a year times 3 years). According to the federal law known as ERISA, you must be 100% vested after no more than 6 years.

Limitations On What You Can Do With The Money

If you are at least 55 and retiring, you can take withdrawals from the account without paying any penalty, although the withdrawals will be subject to income tax.

Otherwise, when you leave employment, your alternatives are:

  • You can withdraw all or part of the money in your account.
    • You can usually withdraw any amount from your 401(k) account at any time after you have terminated your employment. However, if you're under age 59 1/2, you will have to pay regular income taxes and a 10% penalty on the amount of the withdrawal. Also, your employer will be required by law to withhold 20% of the amount distributed.
  • You can rollover the funds to a new employer's plan.
    • The money in your 401(k) can be transferred to another employer's plan. If your money is transferred directly from one plan to another, no tax or penalty will be payable and taxes will not be withheld.
  • You can transfer the money to an IRA rollover or a "conduit IRA."
    • If you transfer the money from a 401(k) plan to a new IRA, all the money must go directly from one institution to another to avoid any tax or penalty. Don't add to or withdraw from this IRA account after transferring money from a 401(k) into it or you may lose the option of one day transferring it to another employer's plan.
  • You may be able to take withdrawals from your account over the course of your life if your Plan allows.
    • This option allows you to withdraw from your account every year. The amount that you must withdraw is based on your life expectancy. If you take this option, you must withdraw at least the minimum amount every year. The simplest method divides your account balance each year by the life expectancy indicated in IRS Publication 590 which is available at www.irs.gov/pub/irs-pdf/p590.pdf. The life expectancy used does not take your health into consideration.

    Consider rolling the money into an IRA which generally provides more investment choices. An IRA is also more flexible concerning leaving the remainder to your heirs.