Changing Jobs: Should You Roll Over Your 401(k)?

Changing jobs? Here are five ways to handle the money in your employer-sponsored 401(k) plan, including some pros and cons of each.

The pros: If your former employer allows it, you can leave your money where it is. Your savings have the potential for growth that is tax-deferred, you'll pay no taxes until you start making withdrawals, and you'll retain the right to roll over or withdraw the funds at any point in the future. Under federal law, assets in a 401(k) are typically protected from claims by creditors.

The cons: You'll no longer be able to contribute to the plan, and the plan provider may charge additional fees because you're no longer an employee. Your allocation to stocks and bonds in the current 401(k) plan might change over time and no longer align with your retirement goals. In which case, you might have to make changes or revisit your decision to keep it with your former employer. Managing multiple tax-deferred accounts can also prove complicated. The IRS mandates required minimum distributions (RMDs) annually from all such accounts beginning at age 73 (assuming you're no longer working for the employer sponsoring the account). RMDs are calculated separately and must be taken out separately for each 401(k). If you fail to correctly calculate your RMD or don't take it on time, you may owe a 25% penalty on the shortfall.

The pros: Assuming you like your new plan's costs, features, and investment choices, this can be a good option. Your savings have the potential for growth that is tax-deferred, and RMDs may be delayed beyond age 73 if you continue to work at the company sponsoring the plan. Generally, you can opt for a "direct rollover" into the new 401(k) that avoids issues with taxes and withholding. And by rolling the funds from one 401(k) to another, your assets will continue to enjoy broad protection from creditors due to federal law.

The cons: Not all 401(k) plans will allow you to rollover an old 401(k). You'll need to liquidate your current 401(k) investments and reinvest them in your new 401(k) plan's investment offerings, which will take time and some research. Be aware that different 401(k) plans generally offer different investment choices (e.g., mutual funds, ETFs, and target-date funds), charge different investment fees, and have their own rules for loans and borrowing from 401(k) assets. The money will be subject to your new plan's withdrawal rules, so you may not be able to withdraw it until you leave your new employer. If you opt for an "indirect rollover," where the funds are distributed to you first, you could face unexpected taxes and penalties. It's best to talk to the administrator for your new 401(k) plan to make sure you roll over the funds in the most tax efficient way for your situation.

The pros: Because IRAs aren't sponsored by employers—you own them directly—you won't have to worry about making changes to your account should you change jobs again in the future. IRA providers may also offer a wider array of investment options and services than either your old or new employer-sponsored plan. You can aggregate RMDs from all IRAs and take them from one account.

The cons: Once you roll your funds into an IRA, they may no longer be eligible for a future rollover into a 401(k) plan, and RMDs apply at age 73, regardless of whether you're employed. Also, you'll need to specify how the funds in your traditional IRA are to be invested. Until you do so, the money will remain in cash or a cash equivalent, such as a money market account, rather than being invested. An IRA with only rolled over assets from a 401(k) retains federal bankruptcy protection, but unlike a 401(k), state laws will determine if other legal liability protection applies.

The pros: Withdrawals are entirely tax-free in retirement, provided you're over age 59½ and have held the account for five years or more from the time you've first funded the account. Roth IRAs are also exempt from RMDs.

The cons: Because Roth IRAs are funded with after-tax dollars, you'll have to pay taxes on your existing 401(k) funds on the conversion. That could push you into a higher tax bracket for the year. If this is your first time contributing to a Roth IRA, you are required to hold the account for at least 5 years before any earnings can be withdrawn tax-free. Also, if you make a withdrawal before you're 59½, you may be subject to a potential 10% early withdrawal penalty, if you do not qualify for an exception.¹ Depending on your situation, you may want to speak to a CPA or a tax professional to better understand the tax implications of any decisions. As with the move into a traditional IRA, by moving the funds out of a 401(k) and into a Roth IRA, you may potentially lose some liability protection from creditors depending on the state you live in.

The pros: In a word: liquidity. If you leave your job during or after the year you turn 55, you can withdraw money directly from your 401(k) without early withdrawal penalties.

The cons: Withdrawals are subject to a mandatory 20% federal withholding and, in some cases, mandatory state withholding. And if you fail to move the money into a qualified retirement plan within 60 days, it is taxed as ordinary income, plus a 10% penalty if you're under age 59½, which means you could end up paying significantly more than the 20% federal withholding, depending on your federal and state income tax rates. You're also limited to taking one 60-day rollover per 12-month period. You may also negatively impact your retirement goals.