Cashing out a 401k when you leave a job costs you income tax, usually a 10% penalty, and decades of growth. Left invested at a 7% average return, $10,000 at age 30 grows to about $107,000 by 65. Ask your old plan for a direct rollover into your new plan or an IRA instead.
The temptation shows up at a bad time. A job change can bring moving costs or a gap between paychecks, and the old 401k starts to look like a spare emergency fund.
The day-one math is worse than it looks. The plan withholds 20% for federal taxes before it sends the check, and the whole withdrawal counts as income that year. In the 22% bracket, taxes plus the 10% penalty take $3,200 of a $10,000 balance before any state tax. You keep about $6,800.
So the real trade is about $6,800 in cash today against the full $10,000 kept invested and growing tax-deferred for decades.
Any of three moves keeps the money growing tax-deferred:
- Roll it into your new employer’s 401k, if that plan takes rollovers, so everything sits in one account
- Roll it into an IRA, which usually offers more investment choices
- Leave it where it is, if the old plan allows it and its fund lineup is solid
Whichever you pick, ask for a direct rollover, which sends the money straight from the old plan to the new account with nothing withheld. If the plan mails you a check instead, it withholds 20%, and you have 60 days to deposit the full balance. Any part you don’t redeposit, including the withheld 20% you’d have to cover from savings, is taxed as a withdrawal.
Small balances need speed. A plan can mail you a check for $1,000 or less without asking. It can also move a balance of up to $7,000 into an IRA it picks if you don’t give instructions, and that account is easy to lose track of. A check you didn’t ask for still starts the 60-day clock.
Choose the destination before your last day, while you can still ask HR how the old plan handles rollovers.
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