What happens to my 401(k) after I left my job to start a business?

Once the adrenaline of quitting your full-time job wears off it’s time to get practical. 

There’s a lengthy laundry list of to-dos to check off once you put your notice in. You need to tie up loose ends at work, hand your remaining projects off to someone else, and figure out what to do about your benefits. 

Multiply that by a factor of one hundred if you are quitting your job to start a business.

In the hustle and bustle of leaving full-time employment, it’s common, your 401(k) plan gets lost in the shuffle. If you’ve been with your company for many years then you may have tens of thousands of dollars saved up, so what happens when you put your notice in? And what are your options to continue saving for retirement?

For those embarking on the journey of entrepreneurship, finances are often the biggest concern. After reading this article you’ll know what to do with your 401(k), and what your best options are to continue saving for the future.

What happens to my 401(k) after I quit my job?

Depending on how long you have been at your job, you may have quite a bit saved away in your 401(k). While it’s tempting to look at these funds as potential runway to get your business off the ground, we have one word for you: don’t. 

If you take money out of your 401(k) before you are 59 ½ years old, you may have to pay a penalty for early withdrawal and pay income tax on the money you withdraw. It’s just not worth it to withdraw early (though there are some retirement savings options for solopreneurs that allow you to take out a loan, more on that later). 

Withdrawing your funds isn’t always the right move, but you do have other options. 

If you have less than $5,000 in your 401(k) then you will probably need to move your funds

If you have less than $5,000 then you may not be able to keep the money in your current plan (many providers do not allow balances this low to remain), which means you will need to withdraw the funds and roll them over into a different retirement plan. 

Make sure to move the money as a direct rollover to an IRA, another employer’s plan, or a plan you set up for your new business, like a Solo 401(k) plan. 

If you take a distribution of the funds made payable to you then you will only receive 80% of your balance since 20% is automatically (withheld) taken from the distribution and sent to the IRS.  Once the distribution is complete, you have 60 days to roll over the funds.  You will be taxed and may be penalized on any amounts not rolled over such as the 20% withheld from the distribution. The only way to avoid the tax and penalty is to roll over the funds which may mean you would have to come up with the 20% out-of-pocket.  

If you have over $5,000 in your plan, you have more options though. 

You could leave your 401(k) with your previous employer

If you have over $5,000 in your plan then one of the simplest options is to leave it as is. 

Just because this is simple though does not mean it should be your first choice. You’ll need to check with the 401(k) provider first, but they may be able to hold your funds indefinitely. This is certainly the easiest option for those unsure of what to do next or waiting to review their options. 

If you want to move your 401(k), you can roll it over into a new retirement plan

If you want to move your 401(k) plan, then you have plenty of options. 

Rolling your 401(k) plan into a new account directly, will not cause you to have any tax consequences because it is not considered a taxable event. When rolling over, you’re not withdrawing money from your retirement savings, you are just moving your retirement savings from one retirement plan to another eligible retirement plan.

The most common recommendation is to roll it over into an IRA, however, that is not the only direction you can go. Your options to roll over your 401(k) plan include:

• A rollover IRA

• A SEP IRA

• A Solo 401(k) (this is a 401(k) plan specifically for solopreneurs)

Being self-employed doesn’t mean you have to forgo the great retirement savings options that came with your full-time job. Read on to learn more about the options available to you and how to choose the best one for your financial goals.

If I am self-employed, what are my best options to save for retirement after leaving my job?

While you can’t participate in your old 401(k) plan, once you make the jump to self-employment there are plenty of options available for you. Note that these plans are also available if you have a side hustle in addition to a full-time job, so don’t wait till you put your notice in to start saving!

The two plans we will discuss here are a SEP IRA and a Solo 401(k). For a deep dive comparison read our guide comparing a Solo 401(k) to a SEP IRA. For a quick overview to see which is right for you, keep reading.

Simplified Employee Pension (SEP) IRA

SEP IRAs are popular because they have been around for decades, and it is one of the simplest ways a business owner can invest and save for retirement. 

Consider a SEP plan as a profit-sharing plan. If your business made a profit for the year then you can share your business profit with yourself (by contributing it to the plan). You can contribute up to 25% of the business’s revenue (20% for a sole proprietorship) up to the annual limit ($66,000 as of 2023, similar to your profit-sharing contribution to a Solo 401(k). Employee deferral contributions however are NOT available under the SEP plan. An annual IRA contribution can still be made above and beyond the SEP contribution.  

As an example, Angela is an S-Corporation owner and makes $100,000 of W-2 income for the year.  She is under the age of 50. Her company does not have any employees. She established a SEP plan. The maximum contribution she can make for herself under the SEP plan is $25,000. Through the SEP IRA, you can then choose what to invest in, whether that be in individual stocks, mutual funds, or ETFs. If you choose a self-directed IRA administrator, you can expand your investing opportunities to real estate, notes, tax liens, and others.

Solo 401(k)

Like the 401(k) from your previous job, a Solo 401(k) plan allows you to save for your retirement, invest, and reduce your taxable income. 

A Solo 401(k) is a retirement plan geared specifically toward the unique needs of self-employed individuals and micro-business owners. One of its most appealing features is that it permits an enrollee to wear two contributor’s hats: one as an employee and another as an employer. 

As of 2023, a Solo 401(k) plan allows you to contribute up to $66,000 and $73,500 if you're 50+. Assuming, of course, your income will support the contribution. 

As an employee of your business:

• You can contribute up to $22,500 ($30,000 if you are 50+ years old)

• Your contributions can be pre-tax, Roth, or a mix of the two.

The employee contributions are also called “effective deferral” or “employee deferral”. These function similarly to how you would contribute to a 401(k) plan with your full-time job. 

The limit however is based on all deferrals you make to all plans you participate in combined. 

As an employer (of yourself):

• You can contribute up to 25% of your compensation if your business is incorporated (around 20% if it’s not)

• These contributions are made on a pre-tax basis and capped at $66,000 for 2023

The limit of $66,000 is the combined limit of the employee and employer contributions. 

That is the beauty of a solo 401(k) - because you contribute to both the employee and employer side, you can contribute more than you would to a 401(k) plan of an employer you work for. 

If an individual’s contributions (deferrals and profit sharing) total an amount below the $66,000 limit, an employee can make an additional non-deductible contribution or after-tax contribution to maximize the contribution up to $66,000. This after-tax contribution however is not like a Roth contribution since the tax-deferred earnings will be taxable upon distribution. 

As an example, Angela is an S-Corporation owner and makes $100,000 of W-2 income for the year. She is under the age of 50. Her company does not have any employees. After making the 25% ($25,000) profit-sharing contribution and the maximum deferrals ($22,500), she can make an additional after-tax contribution of $18,000 to get her to the maximum limit of $66,000.  The after-tax contribution cannot be used as a tax deduction, but it can be used to invest just like the other contributions and the earnings are tax-deferred. 

One thing many solopreneurs overlook, however, is if they are married, their spouse can contribute the same amount to the same plan since they are considered an owner as well.  Assuming of course that the income paid and received by the spouse is enough to support the contribution. 

Are you/are you about to be self-employed? Download a free financial checklist to prepare for the jump to full-time entrepreneurship

Whether you recently quit your job or are still waiting to make the jump to your small business, let us first say “congratulations” and offer a word of advice: things will move fast once you put your notice in. 

Leaving the security of a full-time job to start a business is no simple task, and that complexity gets compounded by financial details, insurance, and other financial headaches. That’s why we have a financial preparedness checklist for new entrepreneurs that you can download. In it, you will get a step-by-step of what you need to set you and your business up for success after you take the leap.

Financial checklist for quitting your job:

Before you quit

You probably have a lot on your mind leading up to the moment you put your notice in, but do not skip these steps!

• Make sure you have at least 6 months saved up While jumping to running a business full-time is exciting (and you have a right to be optimistic), you can’t predict the future. Make sure you have enough to cover expenses for at least the next 6 months. 

• Schedule a checkup with your doctor and refill your prescriptions While you have your employer-provided health insurance, take advantage of it! 

• Double-check your 401(k) vesting schedule Make sure that you are fully vested in your 401(k), otherwise, you will lose the employer contributions to your plan.

After you put your notice in

Once you put your notice in, take care to work through these steps before your last day. 

• Tie up loose ends and hand your work off Even though you’re leaving your job to start a business, make sure you leave on good terms in case you need a reference down the line. Writing up a transition plan and coordinating a handoff for your work will go a long way.

• Spend any unused benefits If you made pre-tax contributions to any benefits (such as commuter or wellness benefits) then make sure to spend them otherwise you may not get them back.

• Review your company’s unused sick pay and vacation policy Make sure to look into your company’s policy on unused sick pay or vacation days. You may be entitled to receive a payment for unused time. 

After your last day

Leaving the safety of a full-time job to start your own business is exhilarating, but can be nerve-wracking as well. Follow these steps to start things off on the right foot.

• Set up health insurance If you have a spouse then you have 60 days to get on their health plan, otherwise, you will need to purchase health insurance for yourself.

• Set up a Solo 401(k) with SEPira(k) and save Just because you left your job doesn’t mean you can’t continue saving up for the future. Open a Solo 401(k) with SEPira(k) to continue saving for retirement!

• Rollover your 401(k) Roll your 401(k) into your new Solo 401(k) plan to get a head start on your savings!