What is the best thing to do with your 401(k) when you leave a job?

For most people, rolling into an IRA is the best option — it gives you the widest investment choices and often the lowest fees. If your new employer has an excellent plan with low-cost index funds, rolling into the new 401(k) is also good, especially if you may need the Rule of 55 exception later. Never cash out — you'll lose 30-40% to taxes and penalties.

What is the difference between a direct and indirect rollover?

A direct rollover transfers money straight from your old plan to the new account — no taxes, no penalties, no withholding. An indirect rollover gives you a check (with 20% withheld for taxes), and you have 60 days to deposit the FULL amount (including replacing the 20% from your own pocket) into a new account to avoid taxes and penalties.

Can I roll a traditional 401(k) into a Roth IRA?

Yes, but you'll owe income tax on the entire converted amount that year because traditional 401(k) contributions were pre-tax and Roth accounts are after-tax. This makes sense if you're in a low tax bracket now and expect higher taxes later. Convert strategically — large conversions can push you into a higher bracket.

Before You Roll Over Your 401(k): 6 Things to Know

Before you roll over your 401(k), make sure you use a direct rollover to avoid the 20% tax withholding, compare fund options and fees, and decide whether an IRA or your new employer’s plan is the better destination. The wrong rollover move can cost you thousands.

6 Things to Check Before Rolling Over

#	Check This	Why It Matters
1	Compare fund options and fees in both plans	New plan may have worse or better choices
2	Use a direct (trustee-to-trustee) rollover	Avoid 20% mandatory withholding on indirect rollovers
3	Know the 60-day rule for indirect rollovers	Miss the deadline = full taxes and 10% penalty
4	Check for company stock (NUA opportunity)	Net unrealized appreciation rules can save big on taxes
5	Consider whether you need the Rule of 55	Only applies to current employer’s plan, not IRAs
6	Decide IRA vs. new 401(k) vs. leave it	Each option has trade-offs

Your Four Options

Option	Pros	Cons
Roll into an IRA	Widest investment choices, often lowest fees	No Rule of 55 access, no 401(k) loan option
Roll into new employer’s 401(k)	Consolidation, Rule of 55 access, creditor protection	Limited to plan’s fund options
Leave in former employer’s plan	No action needed	Limited fund options, may have higher fees, harder to manage
Cash out	Immediate access	10% penalty + income taxes = lose 30-40%

Direct vs. Indirect Rollover

Feature	Direct Rollover	Indirect Rollover
How money moves	Old plan sends directly to new plan/IRA	You receive a check
Tax withholding	None	20% mandatory federal withholding
60-day deadline	N/A	Must deposit full amount within 60 days
Risk of penalties	None (if done correctly)	High — miss deadline and it’s a taxable distribution
IRS reporting	Reported but not taxable	Reported; taxable if not completed
Recommendation	Always use this method	Avoid unless necessary

Indirect Rollover Trap Example

Step	Amount
401(k) balance	$50,000
Mandatory 20% withheld	-$10,000
Check you receive	$40,000
Amount you must deposit within 60 days	$50,000 (full original balance)
If you only deposit $40,000	$10,000 treated as taxable distribution + 10% penalty
Extra cost of the mistake	~$3,700 (taxes + penalty on $10,000)

You must replace the withheld $10,000 from your own funds. You get it back when you file taxes, but you need the cash upfront.

IRA vs. 401(k) Comparison

Factor	IRA Rollover	New 401(k)
Investment choices	Thousands of funds, stocks, bonds, ETFs	Limited to plan menu
Fees	Often lowest (Fidelity, Schwab, Vanguard)	Varies — some plans have high fees
Rule of 55 eligibility	❌ No	✅ Yes (current employer’s plan)
Creditor protection	State-dependent	Federal protection (ERISA)
401(k) loan option	❌ No	✅ Yes
Roth conversion	Easy to do	Plan-dependent
Backdoor Roth IRA	⚠️ Pro rata rule applies	No impact
Required minimum distributions	Start at age 73	Start at 73 (except Roth 401(k))

Special Situations

Situation	What to Do
Balance under $5,000	Former employer may force you out — roll over proactively
Company stock in your 401(k)	Look into Net Unrealized Appreciation (NUA) — could save significant taxes
You have both pre-tax and Roth 401(k)	Pre-tax goes to Traditional IRA; Roth goes to Roth IRA
You plan to do a Backdoor Roth IRA	Roll into new 401(k) instead of IRA to avoid pro-rata tax rule
You’re 55-59½ and leaving your job	Keep in current employer’s 401(k) for Rule of 55 penalty-free access

The Bottom Line

A direct rollover into an IRA (Fidelity, Schwab, or Vanguard) is the right move for most people — widest investment options, lowest fees, and easy to manage. Always do a direct (trustee-to-trustee) transfer to avoid the 20% withholding trap. The only time to roll into a new 401(k) instead is if you need Rule of 55 access, plan to do Backdoor Roth contributions, or your new plan has exceptional funds. Never cash out — you’ll lose a third of your savings to taxes and penalties.