Key Takeaways
- You have four options for an old 401(k): leave it, roll to a new employer plan, roll to an IRA, or cash out.
- Cashing out is almost always a costly mistake — you will owe income taxes plus a 10% penalty if you are under 59½.
- A direct rollover to an IRA typically offers the most investment flexibility and avoids tax withholding traps.
Your Four Options
When you leave a job, one of the most important financial decisions you face is what to do with the money in your former employer's 401(k) plan. This is not a decision to make in haste or by default. The choice you make can have significant implications for your investment options, fees, taxes, and long-term retirement security. You have four primary options, each with distinct advantages and drawbacks.
Option 1: Leave it in the old plan. Most 401(k) plans allow former employees to keep their money in the plan after leaving, as long as the balance exceeds $7,000. Your savings continue to grow tax-deferred, and you retain access to the plan's investment options.
Option 2: Roll it into your new employer's plan. If your new employer offers a 401(k) or similar plan that accepts incoming rollovers, you can transfer your old balance into the new plan, consolidating your retirement savings in one place.
Option 3: Roll it into an Individual Retirement Account (IRA). You can transfer your old 401(k) balance into a Traditional IRA (or a Roth IRA, if you are willing to pay taxes on the conversion). This is the most common choice and typically offers the widest range of investment options.
Option 4: Cash it out. You can withdraw the money as a lump sum. This option is almost always a mistake for reasons we will explore below.
Comparing Your Options
| Factor | Leave in Old Plan | Roll to New Plan | Roll to IRA | Cash Out |
|---|---|---|---|---|
| Investment Choices | Limited to plan menu | Limited to plan menu | Virtually unlimited | N/A |
| Fees | Varies by plan | Varies by plan | You choose (can be very low) | N/A |
| RMD Rules | Starts at age 73 | Starts at age 73 (still-working exception possible) | Starts at age 73 | N/A |
| Loan Access | Usually no (former employees) | Yes, if plan allows | No | N/A |
| Creditor Protection | Strong (federal ERISA) | Strong (federal ERISA) | Varies by state | None |
| Tax Consequences | None (stays tax-deferred) | None (stays tax-deferred) | None if direct rollover | Income tax + 10% penalty if under 59½ |
Why Cashing Out Is Almost Always a Mistake
Cashing out a 401(k) when you leave a job is one of the most expensive financial mistakes you can make. When you take a cash distribution, the entire amount is treated as ordinary income and taxed at your marginal rate. If you are under age 59½, you also owe an additional 10% early withdrawal penalty. Between federal taxes, state taxes, and the penalty, you could lose 30% to 40% or more of your balance immediately.
But the true cost goes far beyond the upfront tax hit. The money you withdraw is no longer invested and compounding for your retirement. The chart below illustrates how costly cashing out a $50,000 balance at age 35 can be compared to rolling it over and letting it continue to grow.
By cashing out $50,000 at age 35, you receive roughly $32,500 after a 25% tax rate and 10% penalty. Had you rolled that same $50,000 into an IRA and left it invested at 7% annually for 30 years, it would have grown to approximately $380,600. The true cost of cashing out is not $17,500 in taxes and penalties — it is more than $348,000 in lost retirement wealth. This is why financial professionals almost universally advise against cashing out retirement accounts when changing jobs.
Direct Rollover vs. Indirect Rollover
If you decide to roll your 401(k) into an IRA or a new employer plan, how you execute the rollover matters enormously. There are two methods, and one is far safer than the other.
Direct rollover (trustee-to-trustee transfer). Your old plan sends the money directly to your new IRA custodian or new employer plan. The check is made payable to the new institution, not to you. No taxes are withheld, no deadlines apply, and the process is seamless. This is the method you should use.
Indirect rollover (60-day rollover). Your old plan sends the money to you personally. The plan is required to withhold 20% for federal taxes. You then have 60 days to deposit the full original amount (including the 20% that was withheld) into an IRA or new plan. If you deposit only what you received (80% of the original), the missing 20% is treated as a taxable distribution — and subject to the 10% early withdrawal penalty if you are under 59½.
If you receive an indirect rollover check for $40,000 from a $50,000 balance (with $10,000 withheld for taxes), you must deposit the full $50,000 into your IRA within 60 days to avoid taxes and penalties on the shortfall. That means you need to come up with $10,000 out of pocket to make up for the withholding. You will get the $10,000 back when you file your tax return, but in the meantime, you must front the cash. This is why a direct rollover is almost always the better approach — it avoids this trap entirely.
Special Considerations
Company stock and the Net Unrealized Appreciation (NUA) strategy. If your 401(k) holds shares of your employer's stock that have appreciated significantly, rolling those shares into an IRA may not be the best move. Under the NUA strategy, you can distribute the company stock to a taxable brokerage account and pay ordinary income tax only on the original cost basis of the stock — not on the gains. The appreciation is then taxed at the more favorable long-term capital gains rate when you eventually sell. This strategy can save substantial taxes for participants with highly appreciated employer stock.
Roth 401(k) contributions. If you made Roth contributions to your 401(k), those funds should be rolled into a Roth IRA to maintain their tax-free status. Do not roll Roth 401(k) money into a Traditional IRA, as this would create unnecessary complications and could result in double taxation.
After-tax (non-Roth) contributions. Some 401(k) plans allow after-tax contributions beyond the normal deferral limits. These after-tax contributions can be rolled into a Roth IRA (and the associated earnings into a Traditional IRA) through a strategy sometimes called a "mega backdoor Roth." If your old plan has after-tax contributions, consult with a financial advisor before initiating any rollover to ensure the funds are directed correctly.
When to Leave It With the Old Employer
While rolling to an IRA is the right choice for most people, there are situations where leaving your balance in the old employer's plan makes sense.
Exceptional investment options at low cost. Some large employer plans negotiate institutional pricing on funds that is not available to individual investors. If your old plan offers extremely low-cost index funds or stable value funds with competitive returns, the cost advantage may outweigh the broader investment flexibility of an IRA.
Stronger creditor protection. 401(k) plans are protected from creditors under federal ERISA law, which provides robust, uniform protection across all states. IRA creditor protection varies by state and is generally weaker. If you are in a profession with high litigation risk, the stronger creditor protection of a 401(k) may be a meaningful consideration.
Age 55 separation from service. If you left your job during or after the year you turned 55 (or 50 for certain public safety employees), you can take penalty-free withdrawals from that specific employer's 401(k). Rolling the money to an IRA would eliminate this option, as IRA withdrawals before age 59½ generally carry the 10% penalty.
There are currently billions of dollars sitting in forgotten retirement accounts across the country. When you change jobs, it is easy to lose track of an old 401(k), especially if the balance is small or the former employer changes plan providers. Old plans can be subject to higher fees, and you lose the ability to make strategic decisions about those assets. Take the time to locate and consolidate all of your retirement accounts. If you are unsure where an old 401(k) might be, the National Registry of Unclaimed Retirement Benefits (unclaimedretirementbenefits.com) and the Department of Labor's abandoned plan search can help you track down lost accounts.
Making the Right Decision for Your Situation
The best choice depends on your individual circumstances — your age, tax situation, the quality of your old and new employer plans, your need for creditor protection, and whether you hold appreciated employer stock. For most people, a direct rollover to an IRA provides the best combination of investment flexibility, low costs, and simplicity. But every situation is different, and the stakes are high enough that it is worth taking the time to evaluate your options carefully or consulting with a financial advisor before making a move.
Whatever you decide, act deliberately. The default option — doing nothing and eventually forgetting about the account — is rarely the best strategy. Take control of your retirement savings at every transition point in your career, and your future self will thank you for it.
This article is for informational purposes only and does not constitute investment advice. All information should be discussed with a qualified financial advisor before implementation.
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