Direct answer: When leaving a job with a 401(k), you have four main options: leave the money in the old plan (if allowed), roll it into the new employer's plan, roll it into an IRA, or cash it out. Cashing out is almost always the worst option (income taxes plus 10% penalty for those under 59.5 reduce the account by 30% to 50%). Rolling to an IRA typically provides the most investment choice and lowest fees. Rolling to the new employer's plan is simpler and consolidates accounts. Leaving in the old plan is fine for large balances with good investment options.
Scenario: New Job and the 401(k) Rollover Decision
Key Takeaways
- Cashing out a 401(k) before age 59.5 triggers income tax at your marginal rate plus a 10% early withdrawal penalty; for someone in the 24% bracket, this is approximately 34% immediately, leaving $66,000 from a $100,000 account.
- A direct rollover (check payable to the new custodian, not to you) avoids the 20% mandatory withholding that applies to indirect rollovers; always request a direct rollover to avoid the withholding trap.
- Rolling to an IRA provides access to the full range of investment options (individual securities, ETFs from any provider, small-cap funds not in the 401(k) plan), typically at lower expense ratios than employer plan institutional options.
- Rolling to the new employer's plan maintains single-account simplicity, preserves the ability to borrow against the 401(k) if the plan allows, and keeps the account protected under ERISA (employer plans have stronger creditor protection than IRAs in some states).
- For Roth 401(k) balances, roll to a Roth IRA (not a traditional IRA) to preserve the tax-free treatment; mixing Roth and traditional rollovers in the same account is not permitted.
The Four Options in Detail
Leave in old plan: allowed if balance exceeds the plan's minimum (often $5,000); convenient but requires monitoring a separate account and may be subject to the plan's limited investment menu and fee structure. Roll to new employer's 401(k): maintains 401(k) advantages (creditor protection, loan option, potential for future backdoor Roth contributions if needed), but limited to the new plan's investment menu and fee structure; check the new plan before rolling. Roll to IRA: maximum investment flexibility, typically lowest cost (Fidelity, Vanguard, and Schwab IRAs have no account fees and provide access to near-zero expense ratio index funds), but loses 401(k)-specific protections. Cash out: generates immediate tax plus penalty; only justified in genuine financial emergency with no other options.
The 20% Withholding Trap
If you request a distribution from your 401(k) and have it paid to you (indirect rollover), the plan must withhold 20% for federal taxes, even if you intend to roll it over. You then have 60 days to deposit the entire original balance (including the withheld 20%) into the new account; if you deposit only 80%, the 20% is treated as a taxable distribution and early withdrawal penalty applies. To avoid this, always request a direct rollover, where the check is payable to the new custodian (e.g., 'Fidelity Investments FBO John Smith') and delivered to you or directly to the custodian. With a direct rollover, no withholding occurs.
IRA Rollover: Practical Steps
Step 1: Open an IRA at the target custodian if you do not already have one. Step 2: Request a direct rollover from the old plan's administrator, specifying the receiving institution and account number. Step 3: The check (payable to the new custodian FBO you) or electronic transfer arrives at the new custodian, who credits it as a rollover contribution. Step 4: Invest the proceeds in your chosen funds at the IRA custodian. Timeline: typically 2 to 4 weeks for the full process. Common pitfall: the check arrives payable to you with 'FBO [custodian]' notation; deposit it at the custodian promptly (within the 60-day window) rather than cashing it.
Roth 401(k) Rollover Considerations
If your old plan includes a Roth 401(k) balance (after-tax contributions + tax-free growth), roll it to a Roth IRA, not a traditional IRA. Rolling a Roth 401(k) to a traditional IRA would undo the tax-free status of the contributions. If your old plan has both traditional (pre-tax) and Roth (after-tax) balances, instruct the plan administrator to split the rollover: traditional 401(k) to traditional IRA, Roth 401(k) to Roth IRA. Plans handle this differently; some issue two checks, some require two separate rollover requests. Confirm the receiving custodian has both account types open before initiating.
Frequently Asked Questions
Is there a time limit on rolling over a 401(k) after leaving a job?
There is no strict time limit on a 401(k) rollover after leaving a job, as long as you leave the money in the plan. You can roll it over months or years later. The 60-day rollover deadline applies only once you have taken a distribution; you have 60 days from receiving the distribution to deposit it in the new account to avoid taxes and penalties. Plans may have their own policies about how long they keep the accounts of former employees; small balances (under $1,000 or $5,000 depending on plan) can be automatically distributed or rolled to an IRA by the plan.
Can I roll over a 401(k) into an existing IRA, or do I need a new account?
You can roll a 401(k) into an existing traditional IRA (traditional 401(k) to traditional IRA only; Roth 401(k) to existing Roth IRA only). Mixing pre-tax 401(k) money into a Roth IRA would be a Roth conversion, not a tax-free rollover. There is no requirement to open a new account for a rollover. One practical consideration: if you ever want to do an indirect backdoor Roth IRA contribution (for high earners exceeding the Roth IRA income limit), having a large traditional IRA balance triggers pro-rata taxation, which reduces the backdoor Roth's effectiveness. Some advisors recommend rolling traditional IRA balances back into a new employer's 401(k) to clear this complication.
Does rolling over a 401(k) count toward my annual IRA contribution limit?
No. Rollovers are not contributions and do not count toward the annual IRA contribution limit ($7,000 in 2024, $8,000 for age 50+). You can roll over any amount from a 401(k) to an IRA in a given year without affecting your ability to make a regular IRA contribution for that year. However, an indirect rollover (60-day rollover where the money passes through your hands) is limited to one per 12-month period across all IRAs; the one-rollover-per-year rule does not apply to direct rollovers.