What Should I Do With My Old 401(k)? It's More Complicated Than You Think
- Christina McNeal
- Dec 7
- 8 min read
Updated: Dec 8
Perspective Matters
KEY TAKEWAYS
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One of the most common questions every financial planner hears is, "What should I do with my 401(k) from my previous employer?" Usually, people phrase it as, "Should I roll over my old 401(k) to an IRA?" The short answer is: it depends.
When we start a new job, we get plenty of information about why we should put money into a 401(k) and how to do it. But there's much less guidance about how, when, and why to take it out. The same is true for IRAs. There's lots of information about the benefits of having these accounts, but the rules for withdrawing money from employer-sponsored plans and IRAs keep getting more complicated with every new piece of legislation. If you accidentally break one of these rules, you can create a serious tax problem for yourself.
UNDERSTANDING YOUR OPTIONS
When you leave a job where you've had a 401(k), you generally have three choices:
Leave it in an employer-sponsored plan. You may be able to keep it with your former employer (if they allow it) or roll it into your new employer's plan (if that's permitted).
Cash it out. Take the money as a lump sum distribution.
Roll it over into an IRA. Transfer the funds to an Individual Retirement Account that you control.
(These guidelines also apply to other employer-sponsored retirement plans, such as 457, 403(b), SEP, and SIMPLE plans. However, there can be important differences between plan types, so it's wise to speak with a Certified Financial Planner® professional before making a decision. Better yet, make sure the CFP® professional is also a member of the Ed Slott Master Elite Advisor Group.)
Within any of these choices, you may also have the option to convert some or all of your money from pre-tax funds to a Roth version of the account. Not every employer plan allows this conversion, but it's worth considering based on your financial situation.
CHOICE ONE: CASHING OUT
Let's start with what seems like the simplest option: taking a cash distribution. This choice comes with significant tax consequences that catch many people off guard.
If you take a cash distribution from your previous employer's 401(k), you will owe income taxes on any pre-tax money in the account. The plan is required to withhold 20% of any pre-tax distribution for taxes. You may also face the 10% early withdrawal penalty, depending on your age and whether you qualify for any exemptions.
Here's something many people don't realize: if your account balance falls below your plan's minimum requirement after you leave, the plan may automatically cash you out and send you a check minus the 20% withholding. This can happen whether you want it to or not.
You might think you can simply deposit that check into an IRA within 60 days to avoid taxes. While 60-day rollovers do exist, they come with strict rules. You're only allowed one 60-day rollover in any 12-month period. Make a mistake, and you've created taxable income and possible penalties. Also, since 20% was already withheld for taxes, if you want to roll over the full original amount, you'll need to come up with that 20% out of pocket. You won't get it back until you file your tax return the following year.
There are legitimate reasons to consider a lump sum distribution. You might need the money now. You might qualify for special tax treatment, such as 10-year averaging or Net Unrealized Appreciation (NUA) on employer stock. Your tax bracket now might be lower than it will be in retirement. Taking a distribution can also reduce your taxable estate and create liquidity for other planning purposes.
However, the rules around these strategies are complex. I can't stress enough the importance of consulting a professional who can explain requirements like the 60-day rollover rules and help you understand the full implications for your specific situation.
CHOICE TWO: KEEPING MONEY IN EMPLOYER PLAN
If your former employer's plan allows it, you can leave your money where it is. Or, if you have a new job and your new employer permits it, you can roll your old 401(k) into your new one. Most employer plans today allow incoming rollovers, but it's always smart to verify.
There are several reasons it might make sense to keep your money in an employer-sponsored plan:
Stronger creditor protection. Federal law protects money in employer plans from creditors. IRA protection varies by state. (The bankruptcy reform law passed by Congress in 2005 does protect a certain amount in IRAs – in 2025 the limit is $1,512,350.)
Life insurance. Your employer plan may include life insurance that cannot be transferred or replaced.
Delayed required distributions. If you're still working when you reach your required beginning date and own less than 5% of the company, you can defer required minimum distributions from an employer plan. You cannot do this with an IRA.
Earlier penalty-free access. If you leave your employer at age 55 or older, you may take distributions from that employer's plan without the 10% early withdrawal penalty. With an IRA, you generally must wait until age 59½. Certain government employees may qualify at age 50 or with 25 years of service.
In-plan Roth conversions. Some employer plans offer Roth options and allow conversions, giving you Roth benefits while keeping your money in the plan.
Lower costs. The investment expenses inside employer plans are often lower than those in IRAs.
However, there are disadvantages to leaving money in an employer plan. Any distributions that include pre-tax money will have mandatory 20% tax withholding, even if you don't actually owe that much in taxes. You won't get the excess back until you file your return.
Plan administrators don't always update their procedures to reflect new legislation, which can limit your options or your beneficiaries' options. Your investment choices are limited to what the plan offers. Some plans require distributions to be taken proportionally from all investments, meaning you might be forced to sell investments that are down. Taking distributions often involves more paperwork. And you won't have access to personalized professional advice from someone working directly for you.
CHOICE THREE: ROLLING OVER TO AN IRA
Rolling your employer plan into an IRA offers its own set of advantages:
More investment options. You can choose from a much wider range of investments, including annuities if appropriate.
Account consolidation. You can bring multiple old retirement accounts together in one place.
Greater estate planning flexibility. You can set up different IRAs for different beneficiaries, including charities, with clear rules under the SECURE Act for how each type of beneficiary must handle inherited accounts.
Simpler distributions. There's usually less paperwork, and you decide which investments to sell when you need money.
More tax planning opportunities. You have greater flexibility for strategies like Roth conversions.
Professional guidance. Your IRA can be managed by a financial planner or investment manager who works for you, not your former employer.
Some creditor protection: The bankruptcy reform law passed by Congress in 2005 does provide some protection for money in IRAs. It’s an inflation-adjusted figure, and in 2025 up to $1,512,350 can be protected by Federal bankruptcy law.
There are also some disadvantages of rolling an employer plan into an IRA. Federal creditor protection is limited. Employer plans may offer loan provisions while loans are prohibited from IRAs. Required minimum distributions will be required, even if you are still working when you reach your Required Beginning Date. If you want professional advice to help with your IRA it will most likely be more expensive that leaving money in your 401(k) and doing it yourself. There is no single “one-size-fits-all” solution, so I encourage you to seek advice from someone you know is acting in your best interest - a fiduciary - and who has the technical knowledge to advise you - a member of the Ed Slott Master Elite Advisor Group.
THE HIDDEN DANGERS OF MOVING MONEY
Whether you're moving money from an employer plan to an IRA or from one IRA to another, the rules can trip you up in ways you might not expect.
When transferring between IRAs, you have two methods. A trustee-to-trustee transfer moves money directly from one custodian to another. A 60-day rollover means the custodian sends you a check, and you deposit it into your new IRA within 60 days.
I strongly encourage trustee-to-trustee transfers whenever possible. You can do unlimited transfers per year. But with 60-day rollovers, you're limited to one in any 12-month period, based on your distribution date. If you accidentally do a second 60-day rollover within that window, the entire second distribution becomes taxable income and may also trigger the 10% early withdrawal penalty.
Another common mistake is missing the 60-day deadline. If that happens, the distribution is fully taxable and possibly penalized. You may have heard that the IRS can grant relief for missed deadlines under certain circumstances through self-certification procedures. That's true. But here's what many people don't know: the IRS has no authority to provide relief for violating the once-per-year rule. That mistake cannot be fixed.
There's an additional rule that catches beneficiaries off guard. If you inherit an IRA from someone who was not your spouse, you can only move that inherited IRA through a trustee-to-trustee transfer. If you take the money out and try to do a 60-day rollover into another inherited IRA, you cannot avoid taxes. The distribution is taxable, period.
THIS IS NOT A COMPLETE LIST
What I've shared here is not an exhaustive list of reasons to keep money in an employer plan or move it to an IRA. Nor is it a complete guide to avoiding unexpected income taxes or early distribution penalties. The rules are simply too numerous and too complex to cover in a single article. You can read more here or schedule a no-obligation consultation with me to discuss your specific situation.
That complexity is exactly why I encourage you to consult a Certified Financial Planner® professional who is also a member of the Ed Slott Master Elite IRA Advisor Group. CFP® professionals are fiduciaries, legally required to put your interests first at all times. Members of the Ed Slott Master Elite IRA Advisor Group receive advanced training in retirement planning strategies and specialize in IRA distribution rules.
Before you make any decision about your former employer's 401(k), get professional guidance. The tax savings from making the right choice, and avoiding costly mistakes, can be substantial.
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Neither Prism Planning and Solutions Group nor Insight Advisors provides tax or legal advice, and nothing in this communication should be treated as such. This communication should not be interpreted as a recommendation for a specific investment, legal or tax-planning strategy. We provide this material for informational purposes only. We have made every attempt to verify that the information contained in this communication is accurate as of the date published but make no warranties. Before making any decisions related to your own tax, legal and/or investment situation you should consult the appropriate professionals.
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