401(k) to IRA Rollover: When It Makes Sense
Leaving your job? You have options for your 401(k). Rolling it to an IRA gives you more investment choices and control, but it's not always the best move. Here's what you need to know.
Your Four Options
When you leave an employer, you can:
- Leave it in the old 401(k) if the plan allows it
- Roll it to your new employer's 401(k) if they accept rollovers
- Roll it to an IRA (traditional to traditional, Roth to Roth)
- Cash it out (usually a bad ideaâtaxes plus 10% penalty if under 59.5)
Advantages of Rolling to an IRA
- More investment options: IRAs offer virtually unlimited investment choices vs. the limited menu in most 401(k)s
- Lower fees: Many 401(k) plans have high expense ratios; you can choose low-cost index funds in an IRA
- Consolidation: Combine old 401(k)s from multiple employers into one account
- Estate planning flexibility: IRAs often have more flexible beneficiary options
- Qualified Charitable Distributions: Only available from IRAs (not 401(k)s) starting at age 70.5
When to Keep Your 401(k)
The Rule of 55: If you leave your job at age 55 or older (50 for some public safety workers), you can take penalty-free withdrawals from that employer's 401(k). This doesn't apply to IRAs or old 401(k)sâjust your current employer's plan.
Other reasons to keep money in a 401(k):
- Creditor protection: 401(k)s have stronger federal protection from lawsuits and bankruptcy than IRAs (which vary by state)
- Stable value funds: Some 401(k)s offer stable value funds with higher yields than comparable money market funds
- Company stock with NUA: If you have highly appreciated company stock, the Net Unrealized Appreciation strategy requires keeping it in the 401(k)
- Still working at 73+: You can delay RMDs from your current employer's 401(k) if you're still working
The Backdoor Roth Complication
Important: If you plan to do backdoor Roth conversions, rolling a 401(k) to a traditional IRA triggers the pro-rata rule. This makes backdoor Roth conversions partially taxable. Consider rolling to your new employer's 401(k) instead.
How to Do a Rollover
Direct Rollover (Recommended)
The money goes directly from your 401(k) to your IRA. No taxes, no withholding, no 60-day deadline to worry about.
Indirect Rollover
You receive a check (minus 20% mandatory withholding). You must deposit the full amountâincluding making up the 20%âinto an IRA within 60 days. You'll get the withheld amount back when you file taxes, but you need to front it.
| Rollover Type | Direct | Indirect |
|---|---|---|
| Withholding | None | 20% |
| Deadline | None | 60 days |
| Risk | Low | Higher |
| Frequency limit | Unlimited | Once per year |
Common Rollover Mistakes
- Rolling Roth 401(k) to traditional IRA: This triggers taxes on all the earnings. Roll Roth to Roth.
- Missing the 60-day deadline: Late deposits are treated as distributionsâtaxable and possibly penalized
- Forgetting about after-tax contributions: These need special handling to avoid double taxation
- Not shopping for fees: Some IRA providers charge high fees or push expensive products
How Talk Through Wealth Helps
Model the long-term impact of your rollover decision:
- Compare fee impact over 20-30 years
- Factor in the Rule of 55 if applicable
- See how a rollover affects backdoor Roth strategy
- Model NUA vs. rollover for company stock
- Project RMD differences between 401(k) and IRA