When you quit your job, what should you do with your 401(k)? This is a question a Reddit poster asked recently. The Reddit user earned a double employer match and managed to amass thousands of dollars in their retirement plan, which was her first 401(k) ever. Now that she’s left work, she received an alert asking what she wants to do with the account, with her listed options including rolling the money into an IRA or withdrawing the funds. 

The Redditor said she knows nothing about investing, but saw that she would be penalized if she took the money out as a withdrawal. Still, she was thinking about doing that since she had thousands more than she put in and she and her husband could use the funds while she is not currently working. So, should she make the withdrawal or opt for the rollover option?

Here’s what to do with a 401(k) when leaving your job

The Redditor, like most people who leave a job with a 401(k), should almost assuredly move her 401(k) funds into an IRA. This is a far better option than withdrawing the money. In fact, even if you are given the option to keep your 401(k) with your current employer or roll it over into a new employer’s 401(k) account, you’re often better off opening an IRA with a brokerage firm and putting the money there instead. 

If you open an IRA and deposit the money, you don’t face significant tax penalties as you would if you withdrew the funds. An early withdrawal means you get hit with a 10% fee on top of owing ordinary income taxes on the distributed funds. The money an early withdrawal provides could also cause you to increase your income so much that you’re pushed into a higher tax bracket and pay even more to the IRS. Obviously, you want to avoid these undesirable consequences of taking money out before age 59 1/2. 

When you open an IRA, you also get more choices for what to invest in than a typical 401(k) offers. And, you don’t have to worry about forgetting the account in the future, which could happen if you end up with a bunch of old 401(k) accounts held by different past employers. This is why it’s often beneficial to move the money over even if you could leave it in your old 401(k) or move the money into a new retirement plan at your current job. 

Early withdrawals are almost never the answer for your 401(k) when leaving work

Just as depositing 401(k) funds into an IRA is almost always the right answer upon leaving a job, withdrawing your 401(k) money is almost always the wrong answer.

Aside from the tax issues mentioned above, there’s an even bigger problem. You are going to lose all the gains the 401(k) account would have made over the rest of your working life — and you’re going to set yourself up for financial insecurity as a retiree. 

See, the younger you are when you start contributing to a 401(k), the easier it is to save enough for retirement. If you cash out your 401(k) when you leave your job, you lose the progress you made and it gets harder to save later in life. You need retirement savings as Social Security doesn’t provide enough to live on, so you should cash out your retirement plan only if you are in serious financial trouble with no other choices.  A financial advisor can help you to decide if that is your situation, and can assist you in determining if there is ever a time when taking money out of a 401(k) makes sense. 

The Reddit user in this post should fill out the paperwork for a direct transfer of the 401(k) funds to a new IRA, which she can open in minutes with any online broker. Since she says she knows nothing about investing, she should likely pick something safe and simple to invest the money in, like an S&P 500 index fund. Then, she should leave that money to grow to help her build a secure future and ideally begin contributing more to the pot once she gets back to work again. 

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