401(k) Rollover: What You Need To Know & Options

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Should you roll over your 401(k) or leave it with your old company? If you’ve recently left a job or you’re thinking about doing so, it’s an important question.

In this article, I’ll review all of the choices you can make with your old 401(k) and help you understand which is best for you.


Table of Contents


What Is a 401(k) Rollover?

A 401(k) rollover involves taking money from your old 401(k) and transferring it to a new 401(k) or to an individual retirement account (IRA).

If you have more than a certain amount in your old 401(k), typically $5,000, you’re allowed to leave it with your old company.

But there are several other choices you can make. I’ll go through each choice and provide perspective from money expert Clark Howard.


Option 1: Roll Over Your 401(k) to an IRA

401k Rollover: Moving your 401(k) funds to an IRA is a popular option.

For many people, rolling over your 401(k) to an IRA is a great option.

To determine whether it’s best for your circumstances, it’s important to understand the tax differences and implications of traditional and Roth retirement accounts.

With traditional retirement accounts, you contribute pre-tax dollars. If you have a traditional company 401(k), your employer sets aside your contributions before taking taxes out of your paycheck, so your contributions are also pre-tax dollars. You’ll eventually pay taxes on those funds, but if you comply with the mandated age restrictions, you won’t pay any penalty for withdrawing the money.

With Roth accounts, you contribute post-tax dollars. You receive income, pay taxes on that income and then contribute it to your retirement account, where it grows tax-free. You won’t have to pay taxes on that money when you withdraw it (if you comply with age restrictions).

Clark prefers Roth IRAs for most people because he thinks taxes will rise in the future. So unless you’re in a high tax bracket, it probably makes mathematical sense to pay taxes now rather than later when you’re in retirement.

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However, most 401(k) plans are “traditional,” that is, funded with pre-tax dollars. If you’re going to roll over your 401(k) to a Roth IRA, you’ll owe taxes on the money you’re rolling over immediately. So with this option, it’s a good idea to first make sure you can stomach the tax burden. You may decide to pay a fee-only fiduciary from the Garrett Planning Network to talk through the tax implications.

If you have a Roth 401(k) (which is unusual), you can roll it into a Roth IRA tax-free.

The process of rolling over a 401(k) to an IRA includes some nuances, so I wrote about how to roll over your 401(k) here.

Reasons To Select Option 1

Here are some reasons you may want to roll over your 401(k) to an IRA.

  • Potential cost savings. Often, the administrator of your 401(k) plan will charge an annual fee. It’s possible to find IRAs with no such fee. IRAs may also offer lower expense ratios. It’s important to compare costs and plans before making any decisions.
  • More investment options. Your investment options inside of a 401(k) tend to be limited. With an IRA, you can invest in specific stocks, bonds, mutual funds and ETFs. You can even link your IRA to a robo-advisor.
  • Less hassle. The life cycles of jobs and companies are faster than ever. If you leave your 401(k) with your old company, you’ll eventually need to track down and communicate with the plan administrator, perhaps years down the road. And if the company ceases to exist, it may be even more of a hassle to track someone down to help transfer your money. Rolling over your 401(k) to an IRA avoids all that potential hassle.

Option 2: Leave Your Money in Your Old Company’s 401(k) Plan

Sometimes leaving your old 401(k) in place is the right choice rather than rolling over your 401(k) to an IRA.

If your old 401(k) has at least $5,000 in it, chances are you’ll be able to leave it where it is.

Clark says that if the 401(k) plan fees at your old and new jobs are equal, you should move it just because it’s “better to reduce the number of accounts you have in your life.

“Over a working lifetime, you could end up with many different 401(k) plans,” Clark says. “I’ve talked to people who have been working for decades and they have five or more ‘orphaned’ 401(k) plans. They can’t even figure out how to contact the administrator of those plans.”

It’s important to evaluate your current 401(k) plan against all other options before making a decision. If the fees in your previous company’s plan are significantly lower, it may be worth it to leave your funds there.

Also make sure you consider the ramifications of leaving your plan with your old company. You may not be able to make partial withdrawals since you’re no longer an employee. You also may not be able to take out a loan against your 401(k).

Of course, you’ll also no longer be making contributions and receiving a company match.

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Again, this may sound like a negative option at this point, but keep reading. It could be a good choice for you.

Reasons To Select Option 2

Here are some reasons you may want to leave your money in your old company’s 401(k) plan.

  • Combination of cost and performance. If your current plan is inexpensive and/or it’s performing well, you may want to stick with what you know. The grass isn’t always greener.
  • You’re between 55 and 59½ and plan to withdraw soon. If you leave your job in or after the year you reached age 55 and you think you’ll start withdrawing funds before you turn 59½, leaving the funds in a 401(k) will allow you to withdraw penalty-free. That applies if you’re laid off, get fired or quit. Keep in mind you’ll still owe taxes on your withdrawals if it’s a traditional 401(k).
  • Legal protection. Funds in a 401(k) usually are protected from creditors in case of bankruptcy or a lawsuit. Federal law doesn’t offer as much protection for IRAs.

Option 3: Move Your 401(k) From Your Old Company’s Plan to Your New Company’s Plan

For some, moving your old 401(k) plan to your new company's 401(k) plan is the best option.

You don’t have to roll over your 401(k) to an IRA. You can transfer the money to your new company’s 401(k).

Again it’s important to evaluate and compare your old 401(k) plan, the 401(k) plan at your new company and your IRA options.

Which is the least expensive? What investment options does each plan include?

If your new plan is similar to your old plan, it may just be easier from a communication and personal organization standpoint to merge your old 401(k) with the plan at your new company.

Reasons To Select Option 3

Here are some other reasons you may want to move your 401(k) from your old company to your new company.

  • Great new plan. If your new company’s 401(k) plan is inexpensive, you like the investment options it provides and it has performed well historically (especially in comparison to your old company’s plan), moving over your funds may be a great idea.
  • Legal protection. As I mentioned before, 401(k) funds get greater protection from creditors under federal law in case of bankruptcy or a lawsuit.
  • Option to delay Required Minimum Distributions (RMDs). If you work after age 72 and your 401(k) plan is with your current employer, you can delay your RMDs. If you’re planning to work after age 72, you may be living on your income and you may not need your 401(k) funds, so letting them continue to grow could be useful.

Option 4: Roll Over Only a Portion of Your 401(k) to an IRA

You don't have to do the same thing with 100% of your old 401(k) dollars.

You don’t have to keep all your 401(k) money in your old plan or roll every dollar into an IRA or a new 401(k) plan. It’s possible to do a little of both.

Reason To Select Option 4

Here’s the main reason you may want to roll over only a portion of your 401(k) to an IRA.

  • Preparing for early retirement. If you leave your job for any reason, you can tap into the funds in your 401(k) penalty-free as early as the year you turn 55. In most cases, you can’t start taking qualified distributions from your IRA until 59½. If you’re going to retire before 59½, it may make sense for you to leave a portion of your old 401(k) alone so you can bridge the income gap between the day you retire and the day you turn 59½.

Option 5: Cash Out Some or All of Your 401(k)

Don't cash out your 401(k) unless you run into a financial emergency.

Whether it’s because they want or need the cash or because figuring out how to roll over a 401(k) to an IRA can be complicated, a large percentage of Americans cash out their retirement plans when they leave a job.

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As of 2017, Vanguard estimated that 31% of U.S. workers who have 401(k)s cash them out when leaving a job. Aon Hewitt estimated the number at 43%. That number is even larger among people in their 20s.

There’s some evidence that the financial hardships many people have suffered because of the COVID-19 pandemic continue to make cashing out look like an attractive option.

According to a Bankrate survey published in May 2020, more than 27% of working or recently unemployed Americans were planning to turn to their 401(k)s or IRAs for a source of income — or they’d already cashed out.

If you’re going through real financial hardship, it’s understandable that you’d consider cashing out as well. But it should be a last resort. Consider the tax disadvantages:

  • You’ll pay a 10% early withdrawal fee unless you meet the age requirements.
  • You’ll also pay between 10% and 37% in federal tax, depending on your 2021 income tax bracket.
  • Depending on where you live, you may also owe state taxes.

If you were to withdraw just $100 from your 401(k) and your annual income is between $40,526 and $86,375 you’d pay $32 in taxes (without even accounting for the potential state tax), leaving you with just $68.

Reasons To Select Option 5

“If for all practical matters, you can’t put food on the table without drawing down some of your retirement money, [then] you draw down some of that retirement money,” Clark says.

Here’s the only reason you should cash out some or all of your 401(k).

  • True financial hardship. If you need the money to pay for necessities such as rent, your mortgage, food or non-elective medical situations, go ahead and cash out the portion of your 401(k) that you need. But don’t cash it all out unless you absolutely have to.

Final Thoughts

Leaving or losing a job usually creates a checklist of things you need to do, which can be stressful.

However, it’s important to take time to consider the best decision related to your 401(k).

Evaluate whether it’s beneficial for you to roll over your 401(k) into an IRA. It could be a helpful move for you financially.


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