What to Do With an Old 401(k)

The four things you can do with a 401(k) when you leave a job, what each costs, and the two traps that turn a rollover into a taxable event.

Leaving a job is the moment most 401(k) money is lost, and it's lost by default, because the cheque is the box on the exit form that needs the least filling in. You have four options. Three of them cost nothing, and the fourth costs income tax plus 10%.

Four options, one taxable, and the taxable one is the easiest to pick

The fourth option is the one the exit paperwork makes easiest, and it's the only one that costs anything. It's also the most expensive ordinary mistake in American retirement saving. I can't prove that, though I've looked and can't find a costlier one this many people make by accident: a $50,000 balance cashed out loses income tax and the 10% on the way out, then every year of growth it would have had, and nothing on the form warns you. Our withdrawal calculator shows what a cash-out would actually leave you, stacked on whatever else you earn that year.

I'd put it more flatly than the table does. Don't cash out. The other three are all defensible, and which one's best turns on fees and the rule of 55, but the cash-out isn't a fourth reasonable choice sitting alongside them just because the form lists it fourth and the IRS lets you.

Ask for a direct rollover, every time

There are two mechanical ways to move the money and only one of them is safe.

A direct rollover sends the balance from the old plan to the receiving account without it ever passing through your hands. Nothing is withheld. There's no deadline, because there's nothing for you to do, and the IRS doesn't hear about it until the Form 1099-R arrives.

An indirect rollover pays you, and you deposit the money yourself within 60 days. The plan has to withhold 20% for federal tax on a distribution paid to you, even when you've told them you intend to roll it over, and to complete the rollover in full you have to deposit the whole original amount, including the 20% you never received, out of your own savings, until the withholding comes back at filing.

So a $50,000 balance arrives as $40,000. You then have 60 days to find $10,000 somewhere else, or the missing $10,000 becomes a taxable distribution, with the 10% on top if you're under 59½.

The once-per-year restriction doesn't apply here either. It governs IRA-to-IRA rollovers and explicitly excludes trustee-to-trustee transfers and plan-to-plan rollovers, so direct is simpler in every respect I can find.

The rule of 55 is the trap, and the standard advice walks you into it

The most expensive rollover mistake has nothing to do with deadlines: it's moving money you might need before 59½.

If you leave a job during or after the calendar year in which you turn 55, distributions from that employer's plan escape the 10% early-withdrawal penalty. Roll the balance into an IRA and the exception is gone, because an IRA has its own narrower list and the rule of 55 isn't on it.

Someone who separates at 56, consolidates into an IRA because that's what everyone says to do, and then needs money at 57 pays 10% they'd never have owed by leaving it alone. If there's any chance of that, leaving the balance in the plan is what keeps the option open. The full list of exceptions sets out which belong to plans and which to IRAs, and they aren't the same list in either direction.

Fees decide it more often than anything else on this page

An old plan keeps charging its fees on a balance that's no longer receiving contributions, and if that plan is expensive the drag runs for decades on money you've stopped adding to, with no ERISA rule to stop it.

Pull the old plan's annual fee disclosure. A large employer's plan with institutional share classes can genuinely be cheaper than a retail IRA; a small employer's plan with an insurance wrapper usually isn't. What that difference costs over the years remaining is often larger than everything else on this page combined, the rule of 55 included.

Small balances get moved without asking you

Plans may force out small balances after you leave. Under the thresholds most plans use, a very small balance can be cashed out and mailed to you, and a modest one can be rolled into an IRA the plan picks on your behalf, often a low-yield default account with fees of its own.

This happens to people who never opened the letter. If you've left a job with a modest balance behind, find out what became of it. Neither outcome is a disaster. Both are worse than deciding for yourself, though, and the IRA a plan chooses for you is rarely the one you'd have chosen.

Rolling pre-tax money into a Roth is a conversion, and it's taxed like one

Possible, and it's a conversion rather than a rollover: the pre-tax amount becomes taxable income in the year you do it. That can be sensible in a low-income year, a gap between jobs being the classic case, and expensive in a year you were fully employed for.

Whether it's worth it turns on the same question as every Roth decision. Your rate now against your rate later. The Roth versus traditional calculator answers that with your own figures, and the two Roth accounts differ in ways that matter once the money is there.

Vesting, loans and employer stock can change the answer before you start

• Is anything unvested? Employer money you haven't vested in is forfeited when you leave, and there's nothing to move. The match calculator shows what you'd keep on your plan's schedule.
• Is there an outstanding loan? An unpaid balance is offset against your account and becomes a taxable distribution, and the mechanics are here. How long you get to undo it depends on what caused the offset.
• Do you hold employer stock? There's a separate treatment for appreciated employer securities that a straightforward rollover gives up. Ask a tax professional before moving anything, because the decision can't be undone.

Three different outcomes hide behind the word offset, and collapsing them is how people miss the deadline. A qualified plan loan offset under IRC §402(c)(3)(C), meaning one triggered by severance from employment or by the plan terminating, can be rolled into an IRA as late as your tax-filing due date for that year, extensions included. An ordinary offset, where neither of those happened, gets 60 days and not a day more. A deemed distribution under §72(p)(1), which is what a missed repayment schedule produces while you're still on the payroll, can't be rolled over at any point. The Form 1099-R tells you which one you're in: code M is the qualified offset, code L is the deemed distribution. Check it before you start counting days.

Frequently asked questions

What should I do with my 401(k) when I leave my job?

You have four options and only one of them is taxable. Leave it in the old plan, move it to your new employer's plan, roll it into an IRA, or cash it out. The first three aren't taxable events. Cashing out is, and before 59½ it costs income tax plus a 10% penalty on money that can never be put back, because next year's contribution limit is still just the limit.

What is the difference between a direct and an indirect rollover?

In a direct rollover the plan sends the money straight to the receiving account and nothing is withheld. In an indirect rollover the cheque comes to you, the plan has to withhold 20% for federal tax, and you have 60 days to deposit the full original amount, including the 20% you never received, which you have to find from your own pocket. Ask for a direct rollover. There's almost never a reason not to.

How long do I have to roll over a 401(k)?

60 days from receiving the distribution, if it came to you. A direct rollover has no clock because the money never reaches you. Miss the 60 days and the whole amount is a distribution: taxable, and penalised 10% if you're under 59½.

Should I roll my 401(k) into an IRA or my new employer's plan?

An IRA usually gives wider and cheaper investment choice. The new plan usually gives stronger creditor protection and, if you leave that job in or after the year you turn 55, access under the rule of 55 that an IRA can't offer. If you might ever want a backdoor Roth contribution, a pre-tax IRA balance complicates it, which pushes the other way.

Can I leave my 401(k) with my old employer?

Usually, if the balance is above the plan's cash-out threshold. It's the lowest-effort option and sometimes the right one, since a good plan with institutional pricing can be cheaper than anything you'd buy retail in an IRA. What it costs you is attention. Forgotten accounts are one of the most common ways people lose track of real money.

Does a 401(k) rollover count as income or get reported?

A rollover is reported but not taxed. You receive a Form 1099-R for the distribution and report it on your return as a rollover, and the receiving institution files Form 5498. A direct rollover carries its own code. Reported and taxable are different things, and this is the case where people mix them up.

The IRS page is the source, and the forced cash-out thresholds are left off this site on purpose

The 60-day limit, the 20% mandatory withholding on a distribution paid to you, and the scope of the once-per-year restriction are all set out on the IRS page for rollovers of retirement plan and IRA distributions. Dollar thresholds for forced cash-outs are set by statute and by your plan document. This page describes how the rule works and doesn't publish a figure for it, because that figure isn't in our verified data file.