Your Guide to 401(k) and IRA Rollovers

How to decide which rollover is right for you

When you leave an employer for a new job or to take a break from working, you have four options for your 401(k) plan:

  1. Roll the assets into an individual retirement account (IRA) or convert them to a Roth IRA
  2. Keep your 401(k) with your former employer
  3. Consolidate your 401(k) into your new employer’s plan
  4. Cash out your 401(k)

Each of these options comes with various rules to keep your tax benefits and avoid possible penalties. You can protect your retirement savings by learning about each option to decide which is the best choice for you.

Key Takeaways

  • If you leave your employer, you can roll your 401(k) plan to an IRA, cash it out, keep the plan as is, or consolidate it with a new 401(k).
  • IRA accounts give you more investment options, but you will have to decide if you want a traditional or Roth IRA based on when you want to pay the taxes.
  • Converting to a Roth IRA may make sense for people who believe they'll be in a higher tax bracket in the future.
  • You may consider leaving your plan as is with your old employer, especially if investment options aren't available in your new plan.
  • Cashing out a 401(k) is often not the best option because of the penalties for early withdrawals.

Rolling Over Your 401(k) to an IRA

You have the most control and the most choice if you own an IRA. IRAs typically offer a much wider array of investment options than 401(k)s (unless you work for a company with a very high-quality plan such as a Fortune 500 firm).

Some 401(k) plans only have a half dozen funds to choose from, and some companies strongly encourage participants to invest heavily in the company's stock. Many 401(k) plans are also funded with variable annuity contracts; these contracts provide a layer of insurance protection for the assets in the plan but can cost participants as much as 3% per year.

By contrast, IRA fees tend to be lower, depending on which custodian and which investments you choose. And with a small handful of exceptions, IRAs allow virtually any asset, including:

If you're willing to set up a self-directed IRA, you can even purchase some alternative investments like oil and gas leases, physical property, and commodities.

Once you decide on the assets you want in your portfolio, you'll have to figure out which kind of IRA you want—a traditional IRA or a Roth IRA. The main difference between the two is the choice between paying income taxes now or later.

Traditional IRA

The main benefit of a traditional IRA is that your investment, up to a certain amount, is tax-deductible when you make the contribution. You deposit pre-tax money into an IRA, and the amount of those contributions is subtracted from your taxable income. If you have a traditional 401(k), the transfer is simple, since those contributions were also made pre-tax.

Tax deferral won’t last forever, however. You must pay taxes on the money and its earnings later when you withdraw the funds. And you are required to start withdrawing them at age 73, a rule known as taking required minimum distributions (RMDs), whether you’re still working or not. RMDs are also required from most 401(k)s when you reach that age, unless you are still employed—see below.

RMDs previously began at age 70½, but the age was raised by the Setting Every Community Up for Retirement Enhancement (SECURE) Act. It was further raised in 2022. If you turned 72 before December 31, 2022, you would have needed to start taking RMDs the year you turned 72.

Roth IRA

If you opt for a Roth IRA conversion, you must treat the entire account as taxable income immediately. You’ll pay tax (federal and state, if applicable) on this amount now. You’ll need the funds to pay the tax and may have to increase withholding or pay estimated taxes to account for the liability. If you maintain the Roth IRA for at least five years and meet other requirements, then your after-tax contribution and any earnings are tax-free.

There are no lifetime distribution requirements for Roth IRAs, so funds can stay in the account and continue to grow on a tax-free basis. You can also leave this tax-free nest egg to your heirs. But those who inherit the account must draw down the account over the 10-year period following your death, as per new rules outlined in the SECURE Act. Previously, they could draw down the account over their life expectancy.

If your 401(k) plan was a Roth 401(k), then it can only be rolled over to a Roth IRA. This makes sense since you already paid taxes on the funds contributed to the designated Roth account. If that's the case, you don’t pay any tax on the rollover to the Roth IRA. To do a conversion from a traditional 401(k) to a Roth IRA, however, is a two-step process. First, you roll the money over to an IRA, then you convert it to a Roth IRA.

Remember this basic rule if you are wondering whether a rollover is allowed or will trigger taxes: You won't pay taxes if you roll over between accounts that are taxed in similar ways, such as a traditional 401(k) to a traditional IRA or a Roth 401(k) to a Roth IRA).

How to Choose Between a Roth or Traditional IRA

Where are you now financially compared to where you think you’ll be when you tap into the funds? Answering this question may help you decide which rollover to use. If you’re in a high tax bracket now and expect to need the funds before five years, a Roth IRA may not make sense. You’ll pay a high tax bill upfront and then lose the anticipated benefit from tax-free growth that won’t materialize.

If you’re in a modest tax bracket now but expect to be in a higher one in the future, the tax cost now may be small compared with the tax savings down the road. That is, assuming you can afford to pay taxes on the rollover now.

Bear in mind that all withdrawals from a traditional IRA are subject to regular income tax plus a penalty if you’re under 59½. But withdrawals from a Roth IRA of your after-tax contributions (the money you already paid taxes on) are never taxed. You’ll only be taxed if you withdraw earnings on the contributions before you've held the account for five years. These may be subject to a 10% penalty as well if you’re under 59½ and don’t qualify for a penalty exception.It’s not all or nothing, though. You can split your distribution between a traditional and Roth IRA, assuming the 401(k) plan administrator permits it. You can choose any split that works for you, such as 75% to a traditional IRA and 25% to a Roth IRA. You can also leave some assets in the plan.

Keeping the Current 401(k) Plan

If your former employer allows you to keep your funds in its 401(k) after you leave, this may be a good option, but only in certain situations. The best reason to do this would be if your new employer doesn't offer a 401(k) or only offers one that's substantially less advantageous. (For example, if the old plan has investment options you can’t get through a new plan.)

Other advantages to keeping your 401(k) with your former employer include:

  • Performance: If your 401(k) plan account has done well for you, substantially outperforming the markets over time, then stick with a winner. The funds are obviously doing something right.
  • Special tax advantages: If you leave your job in or after the year you reach age 55 and think you'll start withdrawing funds before turning 59½; the withdrawals will be penalty-free.
  • Legal protection: In case of bankruptcy or lawsuits, 401(k)s are subject to protection from creditors by federal law. IRAs are less well-shielded; it depends on state laws.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 does protect up to $1 million in traditional or Roth IRA assets against bankruptcy. But protection against other types of judgments vary.

You might want to stick to the old plan, too, if you're becoming self-employed. It's certainly the path of least resistance. But bear in mind, your investment options with the 401(k) are more limited than in an IRA, cumbersome as it might be to set one up.

Some things to consider when leaving a 401(k) at a previous employer:

  • Keeping track of several different accounts may become cumbersome, says Scott Rain, Manager of Consulting Services at Schneider Downs Wealth Management, in Pittsburgh, Pennsylvania. “If you leave your 401(k) at each job, it gets really tough trying to keep track of all of that. It’s much easier to consolidate into one 401(k) or into an IRA.”
  • You will no longer be able to contribute to the old plan and receive company matches, one of the big advantages of a 401(k) and, in some cases, may no longer be able to take a loan from the plan.
  • You may not be able to make partial withdrawals, being limited to a lump-sum distribution down the road.

Bear in mind that, if your assets are less than $5,000, then you may have to notify your plan administrator or former employer of your intent to stay in the plan. If you don't, they may automatically distribute the funds to you or to a rollover IRA. If the account has less than $1,000, you may not have a choice as many 401(k)s at that level are automatically cashed out.

Rolling Over to a New 401(k) 

If your new employer allows immediate rollovers into its 401(k) plan, this move has its merits. You may be used to the ease of having a plan administrator manage your money and to the discipline of automatic payroll contributions. You can also contribute a lot more annually to a 401(k) than you can to an IRA.

Another reason to take this step: If you plan to continue to work after age 73, you should be able to delay taking RMDs on funds that are in your current employer's 401(k) plan, which would include money rolled over from your previous account.

The benefits should be similar to keeping your 401(k) with your previous employer. The difference is that you will be able to make further investments in the new plan and receive company matches as long as you remain in your new job.

But you should make sure your new plan is excellent. If the investment options are limited or have high fees, or there's no company match, the new 401(k) may not be the best move.

If your new employer is more of a young, entrepreneurial outfit, the company may offer a Simplified Employee Pension (SEP) IRA or SIMPLE IRA. These are qualified workplace plans that are geared toward small businesses and are easier and cheaper to administer than 401(k) plans. The Internal Revenue Service (IRS) does allow rollovers of 401(k)s to these, but there may be waiting periods and other conditions.

In 2023, employees can contribute up to $22,500 to their 401(k) plan. Anyone age 50 or over is eligible for an additional catch-up contribution of $7,500.

Cashing Out Your 401(k)

Cashing out your 401(k) is usually a mistake. First, you will be taxed on the money as ordinary income at your current tax rate. In addition, if you’re no longer going to be working, you need to be 55 years old to avoid paying an additional 10% penalty. If you’re still working, you must wait to access the money without a penalty until age 59½. 

So aim to avoid this option except in true emergencies. If you are short of money (for example, because you were laid off), withdraw only what you need and transfer the remaining funds to an IRA.

Don’t Roll Over Employer Stock

There is one big exception to all of this. If you hold your company (or ex-company) stock in your 401(k), it may make sense not to roll over this portion of the account. The reason is net unrealized appreciation (NUA), which is the difference between the value of the stock when it went into your account and its value when you take the distribution.

You’re only taxed on the NUA when you take a distribution of the stock and opt not to defer the NUA. By paying tax on the NUA now, it becomes your tax basis in the stock, so when you sell it (immediately or in the future), your taxable gain is the increase over this amount.

Any increase in value over the NUA becomes a capital gain. You can even sell the stock immediately and get capital gains treatment. The usual more-than-one-year holding period requirement for capital gain treatment does not apply if you don’t defer tax on the NUA when the stock is distributed to you.

In contrast, if you roll over the stock to a traditional IRA, you won’t pay tax on the NUA now, but all of the stock’s value to date, plus appreciation, will be treated as ordinary income when distributions are taken.

How to Do a Rollover

The mechanics of rolling a 401(k) plan over are straightforward. You pick a financial institution, such as a bank, brokerage, or online investing platform, to open an IRA with them. Let your 401(k) plan administrator know where you have opened the account.

There are two types of rollovers: direct and indirect.

How a Direct Rollover Works

A direct rollover is when your money is transferred electronically from one account to another, or the plan administrator may cut you a check made out to your account, which you deposit. The direct rollover (no check) is the best approach. In many cases, you can shift assets directly from one custodian to another, without selling anything. This is known as a trustee-to-trustee or in-kind transfer.

How an Indirect Rollover Works

In an indirect rollover, the funds come to you to re-deposit. If you take the money in cash instead of transferring it directly to the new account, you have only 60 days to deposit the funds into a new plan. If you miss the deadline, you will be subject to withholding taxes and penalties. Some people do an indirect rollover if they want to take a 60-day loan from their retirement account.

Otherwise, the IRS makes your previous employer withhold 20% of your funds if you receive a check made out to you. It's important to note that if you have the check made out directly to you, taxes will be withheld, and you'll need to come up with other funds to roll over the full amount of your distribution within 60 days.

To learn more about the safest ways to do IRA rollovers and transfers, download IRS publications 575 and 590-A and 590-B.

If your plan administrator can't transfer the funds directly into your IRA or new 401(k), have the check they send you made out in the name of the new account care of its custodian. This still counts as a direct rollover. But be sure you still deposit the funds within 60 days to avoid getting hit with penalties.

Can I Have a 401(k) and an IRA at the Same Time?

You can contribute to both a 401(k) and an IRA, though you must stay within the annual contribution limits for both. However, depending on your total annual income, you may not be able to deduct contributions to a traditional IRA on your taxes if you are also covered by a 401(k) at work.

Does Rolling Over a 401(k) to an IRA Count as an IRA Contribution?

A rollover or a conversion does not count as an IRA contribution and does not have to be within the annual contribution limit ($6,500 in 2023, or $7,500 if you are age 50 or above). However, unlike regular contributions, rollovers or conversions from a 401(k) to an IRA cannot be recharacterized.

Do Rollovers Have To Be Reported to the IRS?

Your rollover isn't taxable unless it is from a non-Roth account to a Roth account, but it should be reported on your federal tax return. If there is any distribution that you don't rollover into the new account, you must include the taxable amount of that distribution as income for the year.

The Bottom Line

When you leave a job, you can leave your 401(k) where it is, roll it over into your new employer's 401(k) plan, roll it over into an IRA, or cash it out. To decide which is right for you, consider any associated penalties, fees, and taxes, as well as the range of investment opportunities associated with each employer's plan.

Each type of rollover has its rules. A rollover usually doesn’t trigger tax complications, as long as you move a regular 401(k) into a traditional IRA and a Roth 401(k) into a Roth IRA.

The most important thing is to check your 401(k) balance when you leave your job and decide on a course of action. Neglecting this task could leave you with a trail of retirement accounts at different employers—or even tax penalties should your past employer simply send you a check that you did not reinvest in time.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Internal Revenue Service. "Retirement Topics - Termination of Employment."

  2. Internal Revenue Service. "IRA FAQs."

  3. U.S. Securities and Exchange Commission. "Investor Alert: Self-Directed IRAs and the Risk of Fraud."

  4. Internal Revenue Service. "Traditional and Roth IRAs."

  5. Internal Revenue Services. "IRA Deduction Limits."

  6. Internal Revenue Service. "Retirement Topics — Required Minimum Distributions (RMDs)."

  7. Internal Revenue Service. "Retirement Plan and IRA Required Minimum Distributions FAQs."

  8. Internal Revenue Service. "Publication 590-B, Distributions From Individual Retirement Arrangements (IRAs)."

  9. Internal Revenue Service. "Rollovers of Retirement Plan and IRA Distributions."

  10. Internal Revenue Service. "Rollover Chart."

  11. Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions."

  12. Internal Revenue Service. "Topic No. 558 Additional Tax on Early Distributions From Retirement Plans Other than IRAs."

  13. U.S. Department of Labor. "FAQs About Retirement Plans and ERISA," Page 13.

  14. U.S. Congress. "S.256 - Bankruptcy Abuse Prevention and Consumer Protection Act of 2005."

  15. Internal Revenue Service. “401(k) Limit Increases to $22,500 for 2023, IRA Limit Rises to $6,500.”

  16. Internal Revenue Service. "Topic No. 412 Lump-Sum Distributions."

  17. Internal Revenue Service. "Topic No. 413 Rollovers from Retirement Plans."

  18. Internal Revenue Service. "Retirement Topics—IRA Contribution Limits."

Take the Next Step to Invest
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.
Take the Next Step to Invest
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.