A 401(k) rollover is the process of moving money from a 401(k) at one job to another retirement account — either a new employer’s 401(k) or an Individual Retirement Account (IRA). When you leave a job, you usually have four options for your old 401(k), and a rollover is typically the one that keeps your money working for you while avoiding taxes and penalties.
Why You’d Do a Rollover
When you leave a job — whether you quit, get laid off, or retire — your old 401(k) doesn’t follow you automatically. You need to decide what to do with it. Your options typically are:
- Leave it in the old employer’s plan (if the balance is above $5,000 and the plan allows it)
- Roll it over to your new employer’s 401(k)
- Roll it over to an IRA
- Cash it out — almost always the worst option due to taxes and a 10% penalty if you’re under 59½
Types of Rollovers
- Direct rollover: The money moves directly from your old 401(k) to the new account, account-to-account, with no check written to you. This is the cleanest method — no tax withholding, no risk of a penalty.
- Indirect rollover: Your old plan sends you a check for the balance, and you deposit it into the new account within 60 days. Problem: the plan is required to withhold 20% in taxes from the check. To complete a full rollover, you’d have to deposit the full original amount — making up the 20% from your own pocket — within 60 days. If you miss the 60-day window or can’t cover the 20%, the withheld amount is treated as a taxable distribution (plus a 10% penalty if you’re under 59½).
Best practice: always request a direct rollover to avoid the 20% withholding hassle.
Rolling to an IRA vs. a New 401(k)
- IRA rollover pros: More investment choices (access to low-cost index funds from any brokerage), no employer plan restrictions, consolidates accounts over your career.
- IRA rollover cons: Slightly more work to set up; some IRA accounts don’t offer access to institutional share classes with even lower fees.
- New 401(k) rollover pros: Keeps money in an employer plan, which may have creditor protection advantages; can preserve the ability to take a 72(t) distribution later if you retire before 59½ from a specific employer.
- New 401(k) rollover cons: Limited to the investment options in the new plan; some plans have higher-fee funds.
Roth vs. Traditional: What Gets Rolled Where?
- A traditional 401(k) rolls into a traditional IRA or a new traditional 401(k) — tax-free (no taxes due at rollover; you’ll pay ordinary income tax on withdrawals in retirement).
- A Roth 401(k) rolls into a Roth IRA — also tax-free, and withdrawals in retirement are tax-free.
- Rolling a traditional 401(k) into a Roth IRA is a Roth conversion — the rolled amount is taxable in the year of the rollover. This can be a good strategy in low-income years.
FAQ
- How long do I have to roll over a 401(k)? For an indirect rollover, you have 60 days from when you receive the distribution. For a direct rollover, there’s no strict deadline, but leaving money with a former employer indefinitely isn’t ideal.
- Does a rollover count as a contribution? No. A rollover is not subject to the annual IRA or 401(k) contribution limits — you can roll over any amount.
- Can I roll over a 401(k) while still employed? Typically no — most plans don’t allow “in-service” rollovers until you reach a certain age (often 59½). Check your plan documents.
- Is there a tax on a 401(k) rollover? A direct rollover to a traditional IRA or new 401(k) is not taxable. An indirect rollover is not taxable if completed within 60 days with the full original amount deposited.
- What if my old employer sends me a check for only 80%? They withheld 20% for taxes. To avoid taxes and penalties on the full amount, deposit 100% of the original balance (making up the 20% yourself) into an IRA or 401(k) within 60 days. You’ll get the 20% back as a tax refund when you file.
Final Thought
A 401(k) rollover is one of the most important financial moves you make when changing jobs. Done right (direct rollover to an IRA or new 401(k)), it’s seamless, tax-free, and keeps your retirement savings compounding. Done wrong (cashing out), it can cost you 30–40% of your balance in taxes and penalties and permanently set back your retirement timeline. When in doubt, choose the direct rollover.
Further Reading
- What Is a 401(k)?
- Your First 401(k): Key Decisions to Make
- Surviving a Layoff: Financial Steps to Take
- What Is a Roth IRA?
Disclaimer: This article is for educational purposes only and does not constitute financial, tax, or legal advice. Consult a qualified professional before making financial decisions.