401(k) rollover options explained
Changing jobs leaves a decision behind: what to do with the old 401(k). You have four options — three keep your money growing tax-deferred, and one quietly costs the most.
Your four options
- 1. Leave it in the old plan. Simple, no action needed. But you can’t add to it, you’re stuck with that plan’s fund menu and fees, and small balances can be force-cashed out. Easy to lose track of.
- 2. Roll it into your new employer’s 401(k). Consolidates your retirement money in one place, keeps strong creditor protection, and may allow plan loans. Good if the new plan has low-cost funds.
- 3. Roll it into an IRA. The widest investment choice and often lower fees, with full control. The trade-off: it can complicate a future backdoor Roth (pre-tax IRA balances trigger the pro-rata rule), and IRA creditor protection varies by state.
- 4. Cash it out. Almost always the worst choice — see below.
| Option | Tax hit | Investment choice | Best when |
|---|---|---|---|
| Leave in old plan | None | That plan's menu | Old plan has great, cheap funds |
| Roll to new 401(k) | None | New plan's menu | You want everything consolidated |
| Roll to an IRA | None | Widest, often cheapest | You want control (mind the backdoor Roth) |
| Cash out | Income tax + 10% under 59½ | N/A | Almost never |
The tax trap: direct vs indirect rollover
If you roll over (options 2 or 3), always do a direct rollover — the funds move provider-to-provider and are never taxed. Avoid the indirect rollover, where the check comes to you: the plan withholds 20%, and you must redeposit the full original amount (making up that 20% from your own pocket) within 60 days — or the shortfall is taxed and may be penalized. Same destination, far more risk.
Why cashing out is so expensive
A cash-out is taxed as ordinary income, adds a 10% early-withdrawal penalty if you’re under 59½, and — the biggest cost — permanently removes that money from decades of compounding. Run a balance through our compound interest calculator to see what cashing out today gives up by retirement.
Two reasons not to roll out too fast
Rolling to an IRA is often the right move — but two situations reward keeping the money in the 401(k):
- The "rule of 55." If you leave your job in the year you turn 55 or later, you can take penalty-free withdrawals from that employer's 401(k) — a bridge for early retirees. Roll it to an IRA and you lose that; IRA penalty-free access generally waits until 59½.
- Employer stock and NUA. If your 401(k) holds appreciated company stock, a special tax break called Net Unrealized Appreciation can let you pay long-term capital-gains rates on the growth instead of ordinary income. Blindly rolling the stock into an IRA forfeits it — get advice before you move employer stock.
Traditional or Roth on the way?
A rollover is also a chance to think about tax treatment. Rolling pre-tax 401(k) money into a Roth IRA (a “Roth conversion”) is possible but creates a tax bill now — worth it only in the right years. See why tax diversification matters and compare Traditional vs Roth.
Frequently asked questions
- What can I do with my old 401(k)?
- Leave it, roll it to your new plan, roll it to an IRA, or cash out. The first three stay tax-deferred; cashing out is usually taxed and penalized.
- Direct vs indirect rollover?
- Direct moves money provider-to-provider, never taxed. Indirect sends you a check with 20% withheld and a 60-day redeposit deadline — riskier. Choose direct.
- Should I cash out?
- Rarely — ordinary income tax, a 10% penalty under 59½, and lost compounding make it the most expensive option.
- Are there reasons to keep money in the 401(k)?
- Yes. If you left your job at 55 or older, the "rule of 55" lets you take penalty-free withdrawals from that 401(k) before 59½. And if it holds appreciated employer stock, the Net Unrealized Appreciation (NUA) tax break can be lost by rolling the stock to an IRA — get advice first.