When you leave an employer, the balance in your 401(k) or 403(b) does not have to move. Four options exist. Cashing out makes the tax due at once; the other three depend on details that are specific to your plan.
On this page
The choice
The four options
- Leave it in the old plan. A plan can cash out a vested balance of $7,000 or less. It is not a failure to decide; it is a decision.
- Roll it into the new employer plan. Available if the new plan accepts incoming rollovers.
- Roll it into an IRA. The option that deserves the most scrutiny.
- Cash it out. Taxable as ordinary income, plus an additional tax if you are under the age threshold and no exception applies. The money also leaves the tax shelter for good.
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What actually differs between them
Convenience and investment choice are not the only differences between the options. These are the differences that change outcomes.
Cost
A large employer plan can have access to institutional share classes that cost less than what the same fund costs in a retail IRA. A small plan may not, and can carry recordkeeping fees that an IRA would not. There is no general rule here. Get the plan fee disclosure and compare it against what the IRA would actually cost, including advisory fees if someone will manage it.
Creditor protection
Assets in an employer plan governed by ERISA generally carry broad protection from creditors. IRA protection comes from a different source, is narrower, and varies by state and by whether the claim arises in bankruptcy. If you work in a field with meaningful liability exposure, this difference deserves weight rather than a footnote.
Access before the normal retirement age
A rule exists that allows penalty-free distributions from an employer plan for someone who separates from service in or after the year they reach a specified age. That rule applies to the employer plan. It does not follow the money into an IRA. Rolling over before thinking about when you actually need the money can close a door you wanted open.
Employer stock
If your plan holds appreciated stock of your employer, a provision called net unrealized appreciation may allow the growth to be taxed at long-term capital gains rates rather than ordinary income rates. Rolling that stock into an IRA generally forfeits the treatment permanently. This applies to a narrow group of people, and to them it matters a great deal.
After-tax money and Roth balances
Plans can hold pre-tax, Roth, and after-tax non-Roth money at the same time. Each is handled differently on the way out, and a rollover done without identifying which is which can create an avoidable tax bill or lose track of basis. Ask the recordkeeper for a breakdown by money type before anything moves.
Before you decide
Two mistakes worth avoiding
Taking the check yourself. A direct rollover moves money between institutions without passing through your hands. An indirect rollover pays you, with mandatory federal withholding taken out, and gives you a limited window to deposit the full original amount, including the withheld portion, using other funds. People miss this constantly, and the shortfall becomes a taxable distribution. Ask for a direct trustee-to-trustee transfer and confirm in writing that it is being processed that way.
Cashing out a small balance. The balance that feels immaterial today is the one with the most time left to compound. The tax and penalty are immediate, and the loss is permanent.
Ask for it in writing
A rollover recommendation should come with a written explanation of why it is better for you specifically, set against what leaving the money in the plan would do. Ask for one, and keep it. That is a reasonable thing to ask of anyone, including us.
What to gather before you decide
- The current plan’s summary plan description and fee disclosure
- A balance breakdown by money type: pre-tax, Roth, and after-tax
- Whether the plan holds employer stock, and its cost basis if so
- Whether the new employer plan accepts rollovers in
- Your expected age at first withdrawal
- Any outstanding loan against the plan, and the plan’s rule for it on separation
This page is general educational information and does not account for your circumstances. Plan rules, tax thresholds, and dollar limits change and differ by plan. Verify anything here against your plan documents and current law before acting.
Calculator. Work out this year required minimum distribution. It uses published figures and names its source.
This page is general. Your situation is not.
If a rollover has been recommended to you, the written comparison described above is a reasonable thing to ask for, and it is worth reading with someone before you sign it. We can cover it in a short conversation, at no charge and with no obligation.
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