I Changed Jobs. Should I Roll Over My 401(k)?
By Kevin Estes
Assume Rollover
Today’s topic comes from a recent Q&A session with current and former T-Mobile employees:
Do I keep the 401(k) in the same spot or roll it over?
Great question!
People who change employers often assume they need to roll their company retirement plan to an Individual Retirement Arrangement (IRA) account.
Doing so is encouraged - sometimes aggressively - by financial businesses who have a vested interest in gathering more assets. What these companies earn is often based on how many assets they custody or manage.
However, rolling over the account may not be the right move!
Traditional 401(k)
The employee lowered their taxable income by contributing to their retirement account. Another term for a traditional retirement account is “pre-tax” because the funds haven’t yet been taxed.
Options
Someone who leaves their employer has many options for what to do with their traditional 401(k).
Five of the most common are:
Distribute the 401(k) funds
Roll the 401(k) over indirectly
Roll the 401(k) over directly to an IRA
Roll the 401(k) over directly to another 401(k)
Keep the 401(k)
This article briefly considers the first two and explores the last three options in more depth.
1. Distribute the 401(k) Funds
It’s possible to withdraw the fund from a 401(k) after leaving the company. However, it’s rarely a good idea for a traditional 401(k).
More Tax
The distribution would be taxed as ordinary income.
That may not be a huge deal for a small account balance. However, withdrawing a lot could cause someone to pay a higher tax rate than necessary.
Also, the funds may be moved to a taxable account. The future interest, dividends, and other gains would also be taxed.
10% Penalty
Distributions from a traditional 401(k) before age 59.5 also incur a 10% penalty unless an exception applies.
This additional tax is intended to deter someone from withdrawing the funds early.
Easier to Spend
Moving the funds from a 401(k) to a checking, savings, or taxable brokerage account makes it easier to spend.
Retirement funds are intended to grow for years, if not decades. Removing them could impact someone’s retirement.
Lost Protection
Retirement accounts have creditor protections. Someone can usually keep the balance - even through bankruptcy!
Withdrawing the funds could put them at risk.
Less Financial Aid
Distributing the funds could also increase the cost of other items. College is a good example.
Retirement accounts are generally excluded from the Free Application for Federal Student Aid (FAFSA®). However, taxable accounts are included. A student may receive less financial aid becuase funds are withdrawn from a traditional 401(k).
Tip: Withdrawing all funds from a traditional 401(k) after leaving a company is rarely a good idea.
Nonetheless, distributing funds could be the right move in some fringe situations.
2. Roll the 401(k) Over Indirectly
Another option is to receive the 401(k) funds from the custodian and then decide where to move them later.
Someone typically has up to 60 days to move those funds into another account without having them treated as a taxable distribution.
20% Withholding
The biggest drawback is what the IRS posted:
A retirement plan distribution paid to you is subject to mandatory withholding of 20%, even if you intend to roll it over later.
This is an ugly part of the federal tax code.
Example
Let’s say someone has $100,000 in their traditional 401(k).
They request the funds so they can move it to another pre-tax retirement account within 60 days. The check is made out to them - not to the new custodian.
In that situation:
$20,000 (20%) is withheld for taxes.
The remaining $80,000 is sent to the individual.
Even if they deposit the $80,000 into another pre-tax retirement account within 60 days, they would still have taken a $20,000 distribution!
That $20,000 “distribution” would be subject to income tax and possibly the 10% early withdrawal penalty. Setting the money aside for tax causes it to be taxed!
The way to avoid the taxable distribution is to deposit another $20,000 from a separate source like checking, savings, or a taxable brokerage account.
However, using other funds could generate additional fees and taxes. At the very least, the money wouldn’t be available for other uses.
The good news is that if the full $100,000 is contributed within 60 days, the $20,000 withheld for taxes could be refunded after the next tax return. The bad news is that could take quite a while and there’s some uncertainty.
Avoid Indirect Rollovers
A check made out to the individual makes it more likely that some - if not all - of the funds will be a taxable distribution:
60 days isn’t very long to move all that money and
it might be spent.
Tip: Avoid an indirect rollover.
If the custodan makes the check out to the account holder in error, it may be best to:
not cash the check,
contact the custodian to cancel the payment, and
either do a direct rollover or make the check out the new custodian.
3. Roll the 401(k) Directly to an IRA
Now that we’ve explored a couple options which may not make sense, let’s review three which might.
Benefits of Rolling a 401(k) to an IRA
There are many potential benefits to rolling a traditional 401(k) to an Individual Retirement Arangement (IRA).
Some of these include:
more investment choice
lower cost
better interface
higher education expenses
first-time homebuyers
unemployed health insurance
More Investment Choice
Employer 401(k) plans often only have 20-50 investment options.
It’s easier to manage and negotiate lower rates on fewer investments. However, some investment choices are quite restrictive.
IRA accounts often have thousands of investment options. Someone will likely be able to diversify their portfolio.
Lower Cost
Employer 401(k) plans may not have the same size as IRAs. Larger IRA accounts may have lower costs due to economies of scale.
Also, more investment choices could allow someone to select low-cost investments.
Tip: To find the cost of an investment, search online for the ticker and “expense ratio.” The record-keeping and other itemized fees are usually in addition to the expense ratio.
Better Interface
I often hear how painful it is to navigate employer 401(k) plans.
Keep in mind that these plans are relatively small. The accounts and investment options are maintained specifically for the company.
Employees looking to contribute to a company retirement plan often have no alternative. As such, the company and custodian sometimes underinvest in the user interface.
Some of the most unfortunate restrictions I’ve seen include:
not allowing a participant to change their contribution rates,
not sharing the investment tickers or full names - leaving employees to guess what the actual investments are, and
not publishing the expense ratios - requiring employees to either do additional research or guess at the costs.
These can be major pain points for employees.
Though it’s rarely bad enough to cause an employee to quit, they may be more inclined to roll assets out after leaving the company. This is another way Individual Retirement Arrangements (IRAs) benefit from more assets.
Custodians also don’t have captive investors for their IRAs. As such, these companies work hard to improve the user experience and add helpful resources.
10% Penalty Exceptions
An IRA has slightly different exceptions to the 10% penalty for withdrawing before age 59.5.
According to the IRS, some exceptions available to an IRA not available to a 401(k) include:
qualified higher eduction expenses,
qualified first-time homebuyers - up to $10,000, and
health insurance premiums paid while unemployed.
A rollover from a traditional 401(k) to an IRA may make sense if any of these expenses are likely.
Costs of Rolling a 401(k) to an IRA
Some of the drawbacks of rolling a traditional 401(k) over to an IRA include:
switching logistics,
true-up matching,
vesting,
loan,
rule of 55,
delayed RMDs,
employer stock tax,
creditor protection,
pro-rata challenges,
PLESA,
pass through, and
terminal illness help.
Switching Logistics
It takes time to research and select an appropriate IRA custodian for the rollover.
Funds
It then takes time to move funds from the traditional 401(k) to the IRA.
The new custodian will need information like:
existing custodian name,
account number, and
balance as of the last statement.
The new custodian has an interest in moving the assets into the IRA. The employer 401(k) plan has an interest in the assets staying put.
Tip: When rolling over an account, work with the new custodian to “pull” the account from the 401(k) plan.
Like when using a rope, it’s much easier to “pull” than “push” accounts.
Investments
Custodians prefer to use their own investments. The cost of holding or trading other investments could be higher at the new custodian.
It’s even possible the new custodian won’t support the previous investments and may force the account holder to sell them. That’s less likely with an IRA than it is with a 401(k).
Before rolling an account over to an IRA, ask the custodian whether they support the current 401(k) investments. Knowing that they don’t or that the costs would be high could inform the decision.
Tip: It may make sense to sell the investments before rolling them into a new account.
Leftovers
The time assets are spent in transit could result in lost income or gains. There’s an opportunity of moving funds.
Also, funds might earn an annoying amount of interest or dividends before they fully transfer. The new custodian might pick up what was there and miss interest or dividends not yet posted. That often results in some small remaining balance in the traditional 401(k).
Tip: Check the old 401(k) at least once after transfer to ensure there isn’t more to move. If so, roll them over as well.
More Accounts
Let’s say someone joins another company with its own 401(k) plan. If they roll their previous 401(k) to an IRA, they may have doubled their retirement accounts.
If the old 401(k) earns interest that posts after the balance transfers, it could triple the number of active accounts!
Having several accounts across multiple custodians can make it tough for a loved one to find, access, and manage the finances should something happen to the employee. Each account might require its own login.
Technology has enabled account aggregation across multiple custodians. However, these tools often only have read-only access. That might allow a loved one to see the balances yet not access the funds.
Also, links tend to grow stale over time and break. They require ongoing maintenance.
Tip: Minimize the number of accounts unless there’s a good reason to keep multiple.
True-Up Matching
Another potential cost of rolling a traditional 401(k) to an IRA is a lost company match.
What is a True-Up?
A true-up match is an extra employer contribution made to ensure an employee receives the stated benefit.
Example
Let’s say a 45 year old employee earns $100,000 in 2024. They were aggressive and maxed out their contribution of $23,000 by July 30th.
Their employer has a policy of matching:
100% of the first 3% the employee contributes and
50% of the next 2% the employee contributes each paycheck.
The company matches paycheck contributions up to 4% of income. Since contributions were only made for the first half of the year, the employer matched $2,000.
However, the employee contributed $23,000 for the year - well above the $5,000 contribution needed to receive the $4,000 company match!
Many companies check their records after the year ends. In this case, they would realize they underpaid $2,000 and make that true-up match. T-Mobile usually does so in March.
For more, check out:
401(k) true-up
401(k) plan fix-it guide
How to Match?
It could get hairy if the employee rolls their 401(k) account to an IRA before the true-up match posts.
The former employer might:
try to contribute the match to the employer’s old 401(k) regardless,
reach out to the former employee, and/or
give up.
Tip: It may make sense to keep the old 401(k) account until after the true-up match is received.
Vesting
Another concern is lost vesting with a traditional 401(k).
According to the IRS, employee 401(k) contributions are always 100% vested. However, employee matches can have a vesting schedule.
Two options include:
100% cliff vesting after three years of service
(no matches vest until after three years of service)20% vesting per year after the first year of service
(no matches vest the first year yet are fully matched by the sixth)
If an employee doesn’t stay employed with the company, the employer match could be clawed back out of the account.
There are other vesting schedules. For instance, someone might need to work three out of five years to vest.
In that case, returning to the employer might result in the employee vested that unvested amount. It’s also something a former employee might negotiate if considering a return to the former employer.
Tip: It may make sense to keep the old 401(k) plan until the match clawback occurs.
Loan
A more common example is the loss of a loan.
According to the IRS, someone can usually take out a 401(k) loan up to the lesser of:
50% of their vested balance and
$50,000.
If 50% of the vested balance is less than $10,000, they can borrow up to $10,000.
Existing Loan
Not all employer plans require a 401(k) loan to be paid back as soon as an employee leaves.
However, rolling over a traditional 401(k) to an IRA would cause an outstanding loan to be due almost immediately.
If someone is unable or unwilling to pay the outstanding loan balance, it’s treated as a distribution. The loan balance would be subject to both income tax and possibly the 10% early withdrawal penalty.
No IRA Loans
It could get worse for those who need the money. A loan cannot be taken out on an IRA.
Someone who took out a 401(k) loan could have limited options to quickly repay it if they roll the account over to an IRA.
Tip: It may make sense to keep a previous employer 401(k) if it has an outstanding loan balance.
Rule of 55
One exception to the 10% penalty for 401(k) distributions is:
Distributions made to you after you separated from service with your employer after attainment of age 55.
If someone leaves their employer after age 55, they can withdraw funds from their 401(k) without having to pay the 10% penalty.
There’s an even better rule for those who served as a qualified public safety employee or firefighter. They can avoid the 10% penalty if they leave after age 50.
These benefits would be lost if the pre-tax 401(k) is rolled over to an IRA.
Delayed RMDs
When someone currently reaches age 73, they must start withdrawing funds from their traditional retirement accounts. The amount they must remove each year is called a Required Minimum Distribution (RMD).
The percentage that must be withdrawn each year increases with age. Essentially, the government gets impatient and wants the deferred tax. RMDs are an attempt to receive the tax during the owner’s lifetime.
If someone’s still working, their 401(k) plan isn’t subject to Required Minimum Distributions - unless they own more than 5% of their employer.
Here’s how the IRS puts it:
Account owners in a workplace retirement plan (for example, 401(k) or profit-sharing plan) can delay taking their RMDs until the year they retire, unless they're a 5% owner of the business sponsoring the plan.
This is a little like the lost vesting. If someone plans to return to their previous employer later in life, it may make sense to keep the old 401(k).
However, if someone feels they might work at their new employer past age 73, they might want to instead roll the funds into the new company’s 401(k) plan. It may also make sense to roll other retirement accounts such as a traditional IRA into the new employer 401(k).
Employer Stock Tax
If the traditional 401(k) was matched with employer stock, it may qualify for a special tax treatment called Net Unrealized Appreciation.
Specifically, the gain on the stock after the employer contributed it could qualify for long-term capital gains. It also wouldn’t need to be sold right away.
Lump-Sum
To qualify for Net Unrealized Appreciation, the entire account would need to be distributed as a lump-sum within a single tax year. That includes the employee contributions.
Limited Options
Rolling the traditional 401(k) to an IRA could result in two options:
lose the Net Unrealized Appreciation or
distribute the employer stock and pay ordinary income tax based on the stock’s value when it was contributed.
Diversification
Distributing it may not be a bad idea! It could be worth paying tax now to diversify the portfolio. Selling is especially appealing because the gain on the stock after the employer contributed it would be taxed a lower long-term capital gains rate.
Tip: If a traditional 401(k) includes appreciated employer stock, look into Net Unrealized Appreciation and/or consult a professional.
Creditor Protection
A 401(k) has federal protection from creditors. It also includes some spousal rights. According to the IRS:
Depending on the type of benefit distribution provided under your 401(k) plan, the plan may also require the consent of your spouse before making a distribution.
It may take a Qualified Domestic Relations Order (QDRO) to remove funds from a 401(k). That’s not the case for an IRA.
According to a couple sources, the 2024 IRA federal creditor protection limit is $1,512,350. The IRA protections may also depend on state laws.
Is Your IRA Safe from Creditors?
Can Your 401(k) or IRA Be Seized If You File for Bankruptcy?
How Safe from Creditors Is Your 401(k) If You Roll It to an IRA?
Overall, a 401(k) appears to be slightly safer from creditors than an IRA. Rolling it over could result in slightly more risk to the IRA.
Pro-Rata Challenges
Another concern is with what’s called the pro-rata rule.
If a 401(k) has both pre-tax and after-tax contributions, it needs to be handled carefully.
You can’t just take a distribution of only the after-tax amounts and leave the rest in the plan.
However, someone could roll over the:
pre-tax amounts to a traditional IRA and the
after-tax amounts to a Roth IRA.
Other 10% Penalty Exceptions
A 401(k) plan has exceptions to the 10% penalty an IRA does not.
Some of these include:
the new Pension-Linked Emergency Savings Accounts (PLESAs)
the dividend pass through from an Employee Stock Ownership Plan
distributions after someone is diagnosed with a terminal illness
If these features are important, it may not make sense to roll a traditional 401(k) over to an IRA.
4. Direct Rollover from the 401(k) to Another 401(k)
If the employee joined another company, it may make sense to roll their previous 401(k) to their new company’s 401(k).
Typically, someone can transfer funds into the 401(k) while they’re eligible for the plan and employed by the company.
Benefits of Rolling a 401(k) to Another 401(k)
Two benefits of rolling a 401(k) into another one are:
fewer accounts
more loan flexibility
Fewer Accounts
Rolling a previous employer 401(k) into a new employer 401(k) could cut the number of retirement accounts in half.
Fewer accounts require less ongoing maintenance. Streamlining could also ease the logistical burden on loved ones should something happen to the employee.
More Loan Flexibility
The 401(k) loan maximum is capped at the lesser of:
50% of the vested balance and
$50,000.
Combining accounts into the new employer 401(k) will likely increase the balance available for a loan.
Existing Loan
Doing so would be challenging with an outstanding loan on the previous employer 401(k).
In that case, the options may be to:
keep the old 401(k),
pay off the loan with other funds, or
pay the income taxes and potential 10% early withdrawal penalty.
One Loan Limit
Someone may only allowed to take one 401(k) loan at a time. They often need to pay back the loan in full before taking out a new loan.
Taking out a smaller loan could prevent them from borrowing up to $50,000 in total. If someone needs to take out a smaller loan and feels they might need to do so again soon, they could be ahead to take out a larger initial loan.
Sell Investments
A 401(k) loan isn’t like a mortgage. It doesn’t increase leverage.
Some investments are sold to raise the cash for the loan.
Paying Self
A 401(k) chargest interest like a regular loan. However, the interest goes back to account owner - not a bank!
Does Not Lower Other Contributions
In 2024, the most someone younger than 50 years old can contribute to a traditional 401(k) is $23,000. However, the amount repaid on a loan does not count toward the maximum.
Let’s say someone takes out a $50,000 five-year loan. With a 9% interest rate, the payments would total about $12,455 each year.
The employee could still contribute $23,000 with regular contributions. With the loan, their total contributions could be about $35,455.
Tax Inefficient
Paying interest on the loan is tax inefficient.
It’s repaid with after-tax dollars. However, it’s going into a pre-tax account which will later be taxed. Paying it off early could save some lifetime taxes.
Tip: It may make sense to pay off a 401(k) loan once possible to open access to future loans, maximize investment growth, and avoid tax-inefficient interest.
Costs of Rolling a 401(k) to Another 401(k)
Rolling a 401(k) plan to another also has some negatives.
Some of these drawbacks include:
switching logistics,
true-up match,
vesting, and
Net Unrealized Appreciation.
Switching Logistics
Rolling one traditional 401(k) to another has some of the same logistical challenges as rolling a traditional 401(k) to an IRA.
However, it may be more challenging to roll to a 401(k) because of:
limited investment options and
the user interface.
Company Matching
As with rolling the old 401(k) to an IRA, rolling it directly to the new company’s 401(k) could result in a lost:
true-up match if moved before the contribution is made and
vesting if someone were to return to the previous employer.
Net Unrealized Appreciation
Rolling over the entire account could eliminate the benefit of Net Unrealized Appreciation.
If the benefit is lost, the appreciation of employer stock would be taxed at the higher ordinary income tax rates instead of at long-term capital gains rates.
IRA Benefits
Rolling the 401(k) to another one misses out on the benefits of an IRA such as:
more investment choice,
lower cost, and
better interface.
It also misses out on the IRA-specific exceptions to the 10% penalty like:
higher education expenses,
first-time homebuyers, and
health insurance premiums while unemployed.
401(k) Similarities
The new 401(k) could be similar to the old one.
Similar Setups
The plans may have similar:
investment choice,
costs, and
user interfaces.
Of course, those would depend both on the previous and new companies’ 401(k) plans.
The new plan could also:
avoid pro-rata complications,
provide slightly more creditor protections, and
delay Required Minimum Distributions if still working.
Similar 10% Exceptions
The 401(k) plan would have many of the same exceptions to the 10% penalty for early withdrawals.
The exceptions include distributions:
following separation from service after age 55,
to a Pension-Linked Emergency Savings Account (PLESA),
due to Employee Stock Ownership Plan dividend pass through, and
after someone is diagnosed with a terminal illness.
The exceptions may be even more beneficial because of the larger combined account balance.
5. Keep the Existing 401(k)
Employees can often keep the traditional 401(k) with their previous employer. That isn’t likely if the company went out of business.
Benefits of Keeping the Traditional 401(k)
There are many benefits of keeping the existing 401(k) account, including:
no switching costs,
loan flexibility,
true-up match,
vesting,
Net Unrealized Appreciation (NUA),
rule of 55,
creditor protection,
pre-rata avoidance,
ESOP dividend pass through, and
terminal illness help.
No Switching Cost
Inertia is tough to overcome, which is why people often accumulate many accounts. It takes work to streamline!
Not changing accounts can be the easiest path. Even if the interface is challening, someone may have years of familiarity with it.
Loan Flexibility
Keeping the previous 401(k) could increase loan flexibility.
A loan from the old 401(k) may not need to be repaid right away. It could continue to be repaid with regular payments.
In addition, the 401(k) with the new company may become loan eligible. The available loan could grow with the vested balance.
If needed, someone could have two outstanding 401(k) loans - one with each plan.
True-Up Match
If someone is expecting a true-up match, it probably makes sense to keep the old 401(k) account until it posts.
Automatic payments are more likely to go through.
Vesting
Keeping a 401(k) from a previous employer may make sense if:
the former employer has an abnormal vesting schedule and
the account holder may return to work for the company.
Net Unrealized Appreciation
NUA is a really nice feature for highly appreciated employer stock used for 401(k) matching.
Someone may be able to wait until they have less income to distribute the account in a lump-sum and pay tax on the value of the stock the employer contributed.
However, it’s important to consider diversification. Net Unrealized Appreciation has single stock exposure. A falling stock price could hurt.
Tip: It may make sense to take a lump-sum distribution and sell the stock to diversify instead of holding Net Unrealized Appreciation.
Rule of 55
This benefit is an important one if the former employee turned 55 before they left the company. In that case, the account owner could withdraw funds without incurring the 10% penalty for early withdrawal.
The age for qualified public service emplees and firefighters is 50.
Same Other Benefits
Keeping the old 401(k) would maintain many of the other 10% penalty exceptions, especially distributions after someone is diagnosed with a terminal illness.
Keeping it could also:
avoid pro-rata complications,
maintain the Employee Stock Ownership Plan dividend pass through, and
provide strong protection from creditors.
Costs of Keeping the Traditional 401(k)
Some of the drawbacks of keeping the old 401(k) include:
more accounts,
delayed RMDs,
PLESA,
investment choice,
cost,
interface,
higher education expenses,
first-time homebuyers, and
unemployment health insurance.
More Accounts
If someone changes positions, they will likely have access to a new retirement plan. Keeping the old one would increase the number of accounts.
The long-term hassle of maintaining multiple accounts cannot be overlooked. It’s critical to maintain access and keep track of what’s going on with the accounts.
Delayed RMDs
Unless the employee returns to work for the previous employer, they’ll likely be forced to take Required Minimum Distributions (RMDs) from the old 401(k).
If someone plans to continue working into their mid 70s, it may make sense to roll the 401(k) into the new employer retirement plan.
Tip: If someone plans to work until their mid-70s, it may make sense to roll pre-tax accounts into their employer plan.
PLESA
A Pension-Linked Emergency Savings Account (PLESA) enables someone to contribute up to $2,500 to a separate Roth (after-tax) account.
They need not demonstrate an emergency to be able to access the funds. Also, there cannot be any fees or charges on the first four withdrawals from the PLESA in a plan year.
An employee can access their PLESA balance after they leave the employer. However, they would not be able to contribute more.
IRA Benefits
As with rolling the account to another 401(k), the previous employee would miss out on the benefits of an IRA.
Some of those benefits could include:
more investment choice,
lower costs, and
a better interface.
They would also miss the IRA-specific exceptions to the 10% penalty like:
qualified higher education expenses,
qualified first-time homebuyers - up to $10,000, and
health insurance premiums while unemployed.
If these are important, it may make sense to consider rolling the balance over to an IRA instead of keeping it in the 401(k).
I hope this helps!
If you’re interested in a review of your specific situation…
Disclaimer
In addition to the usual disclaimers, neither this post nor these images include any financial, tax, or legal advice.
