Millions of Americans will at some point face the decision of what to do with their old 401(k) accounts as they switch jobs or find themselves out of work. If this is the case for you, it may be a good time to consider your options with your 401(k).

If you’re currently unemployed or struggling to earn enough to get by, worrying about your distant financial future may seem unimportant when you have immediate pressing needs now. Still, the decisions that you make today can cost you a lot more in the future, so it’s smart to weigh your 401(k) rollover options.

Below are the key choices for a 401(k) rollover and when each might be right for your situation.

4 key options for a 401(k) rollover

As you’re considering where to roll over your 401(k), you’ll want to consider the advantages of each account type, the drawbacks, your own financial situation and the tax implications.

Depending on how much you have invested in your plan, you may have a limited time to make this decision, and in some cases your former company can make the decision for you:

  • If you have less than $1,000, your ex-employer can just cash you out. You can still roll over the money into another account, but you typically must do so within 60 days.
  • If you have between $1,000 and $5,000, your ex-employer can move the money into an IRA of its choice. If you don’t like that IRA, you can always move it.
  • If you have more than $5,000 in your 401(k), your company must await your instructions on how to proceed. You could continue to leave your money in your old 401(k).

(These options will change in 2024, due to the recently enacted SECURE Act 2.0, which raises the $5,000 threshold to $7,000. The new law also allows money transferred by an old employer into a default IRA to be automatically transferred to the new employer’s retirement plan.)

The specific rules vary from employer to employer, and the rules that apply to your old 401(k) can be found in the plan’s documents. So check there first, if you’re unsure how to proceed.

1. Rollover into a new company’s 401(k) plan

A rollover into your new company’s 401(k) plan may be the easiest option for you. You’ll keep all the money in one place, and you may be able to access some professional advice as part of your new plan, too. So a rollover to a new 401(k) is a winner for convenience. It’s also a winner from a tax perspective because you won’t incur any new taxes as long as you transfer to the same type of 401(k) at your new employer.

In addition, having all your money in a 401(k) protects you from the pro-rata rule. This rule could really trip you up and limit the effectiveness of a backdoor Roth IRA, which is a useful strategy if you earn too much to contribute directly to a Roth IRA.

One downside, however, is that your new plan may have unattractive investment choices, for example, expensive funds. So you’ll want to consider your investment options, too.

2. Rollover into a traditional IRA

A rollover into a traditional IRA is another strong choice, because you’ll still enjoy substantial tax benefits. You’ll be able to defer taxes on any gains, and you can continue to add to your IRA, up to $6,500 annually (in 2023) and enjoy the tax breaks on any income you stash there.

Another advantage is that you’re able to invest in whatever you want, so you can pick a top-performing low-cost index fund or opt for a risk-free IRA CD. Some might see the flexibility of a traditional IRA as a disadvantage, because it requires them to make investment decisions, and so many people will need the advice of a financial professional.

But the traditional IRA has disadvantages, too, including required minimum distributions (RMDs) when you reach age 73 – an issue that plagues 401(k) plans, too – meaning you’ll have to withdraw money whether you want to or not.

If you opt for a traditional IRA, you’ll want to be careful that you make the transition exactly how you intended it. Money from a traditional 401(k) can go into a traditional IRA, but it could also go into a Roth IRA (see the next option). If you decide to move from a traditional 401(k) to a traditional IRA, you’ll avoid any immediate tax liability from the rollover. But you’ll incur a tax liability if you move money from a traditional 401(k) to a Roth IRA.

If you opt to roll over your money into an IRA, here are the best brokers for a 401(k) rollover.

3. Rollover and convert to a Roth IRA

Another option is to roll over your 401(k) into a Roth IRA. The Roth IRA provides enviable tax advantages such as never paying taxes on gains when the money is withdrawn in retirement. It also offers attractive estate planning advantages and no RMDs. These are some of the reasons that many experts prefer the Roth IRA over the traditional IRA.

If there’s any disadvantage to a rollover into a Roth IRA, it occurs if you have money in a traditional 401(k). If you move from this kind of 401(k) to a Roth IRA, you’ll be hit with taxes to compensate for the taxes you’ve already deferred in the traditional 401(k). This burden, which can be quite high, is one reason that many workers move their money into a traditional IRA.

If you have a Roth 401(k), you can roll over your money to a Roth IRA without creating extra taxes. This is also a popular maneuver when retirees near the age to take RMDs, though 2022’s SECURE Act 2.0 eliminates Roth 401(k) RMDs from 2024. By switching to a Roth IRA, you can avoid this requirement entirely.

However, many savers may have a traditional 401(k) that they’re not aware of. If you receive matching contributions from your employer, those contributions are typically put into a traditional 401(k), regardless of which kind of 401(k) you have. If you have a Roth 401(k) and receive an employer match, you’ll have to figure out how you want to deal with this extra traditional 401(k) account. However, the SECURE Act 2.0 is even shaking up this established practice, so you’ll want to double-check to see which kind of account your matching funds pertain to.

This Roth IRA calculator can help you tally up how much tax-free money you can amass.

4. Rollover into an annuity

Another option is to roll your 401(k) into an annuity, which can still be held within the tax-friendly embrace of an IRA, helping you avoid taxes until they’re necessary. The advantages of an annuity are that it can provide stable income with a guaranteed return. When participants tap the annuity, they can receive a regular pension-like income. Many savers like this security, and they don’t need to worry about investing their money, a process that some don’t want to handle.

The downsides for an annuity include the relatively high sales commissions that can sometimes be hidden in the sales contract. The types of annuity contracts can be incredibly complex, with all types of restrictions and caveats, depending on what the annuity company offers. Some annuities can be much more complex than others, depending on the features you need.

Another downside is that once you buy the annuity, the money is typically locked in for some period, so it may not be readily accessible if you have an emergency and need cash. If you’re still within the lock-up period, you’ll usually have to pay a hefty surrender fee to access your money.

Annuities divide many financial experts, because of their various pros and cons, in particular their costliness and complexity. If this route appeals to you, speak with a fee-only financial advisor who is a fiduciary in order to access objective advice about whether an annuity is right for your situation. Many “advisors” are actually disguised salespeople, so beware.

Avoid taking the cash

When times get tough, it can be easy to see the cash in your retirement account and consider tapping that to help get you through. But more than one-half of Americans have said they already feel behind on retirement savings, according to one Bankrate survey.

Taking an early withdrawal comes with a heavy cost. If you take money out of a 401(k) before retirement age (59 ½), the IRS will hit you with a 10 percent bonus penalty on top of the taxes that you’ll already owe. In addition, you may have to sell investments at low prices, and you’ll lose any potential appreciation over your working years, hitting your nest egg still more.

If you must tap your retirement account, see if your plan allows you to borrow against the money in the account. You’ll have to repay the funds, of course, but you may be able to avoid the taxes, which is a win in itself. You may also see if you can take a hardship withdrawal.

What to consider when rolling over a 401(k)

If you’re not required to move your money from your old 401(k) account, consider leaving the account open. Ask yourself a few questions to see if you really do need to do a rollover:

  • Does a new rollover account offer valuable features such as greater investment options or cheaper funds? If so, it could make sense to roll over your account.
  • Do you value the convenience of having your money consolidated in one place? If so, it could make sense to roll over your 401(k).
  • If you roll over your 401(k) to an IRA, do you have the ability or resources to manage it yourself? With an IRA you’ll have to manage your investments or hire someone to do it for you. If you’re not up to that job, it may make sense to stick with your current plan.
  • If you roll over your 401(k) to an IRA (instead of another 401(k) plan), are you alright with losing some of the 401(k)’s benefits such as the ability to take out a loan? You’ll want to consider whether you need any special features of the 401(k) before you move it to an IRA.

Those are some of the key issues you’ll want to consider as you’re considering a rollover. Above all, try to avoid making an emotional decision in managing your money, such as doing a rollover simply to get away from your old employer. Instead, make the best money decision for you.

What is a required minimum distribution (RMD)?

RMDs are withdrawals that retirement account owners are required to take after they retire. This rule applies to accounts such as traditional IRAs as well as to employer-sponsored retirement plans such as 401(k)s. As mentioned, RMDs will apply only to traditional IRAs and traditional 401(k) accounts – and no longer Roth 401(k) accounts – starting in 2024, per SECURE Act 2.0.

Currently, the rule specifies that owners of these plans must take distributions beginning at age 73, starting in 2023. However, you have until April 1 of the year following the year you turn 73 to start taking distributions. For instance, if you turn 73 in August of 2030, you have until April 1, 2031 to start taking distributions. After that, there will be penalties for not taking distributions.

Once you begin taking RMDs, you generally have until Dec. 31 of the current year to take that year’s RMD.

There are also exceptions to this rule. For example, you may not have to start taking RMDs if you are still working; generally, you can wait until you retire. And Roth IRAs do not have an RMD.

What is a direct rollover?

A direct rollover is a distribution of assets from one plan into another. For instance, you may request a rollover of the investments in your traditional 401(k) into a traditional IRA. The benefit of this approach is it allows you to maintain your investments without creating a taxable event. Plus, you can roll multiple old 401(k) plans into a rollover IRA, making them easier to manage.

As noted previously, while it is possible to move investments directly from a traditional 401(k) to a Roth IRA, you will create tax liabilities because the flow of money into the Roth IRA is considered a contribution. So, this option may not be worth it unless the benefits outweigh the costs.

It’s also worth noting that direct rollovers have a deadline. If you opt for a direct rollover, the process must be completed within 60 days to avoid the possibility of penalties. This means the entire process of moving the funds from the old account into the new account must happen within 60 days.

If the funds have been moved out of the first plan but are not yet deposited into the new account, you may be hit with penalties. So, if you prefer a direct rollover, be sure you can move the funds quickly into the new account when the time comes. Also, you may want to ask your old plan provider how long it takes for them to move the money out, so you know when it will be your turn to act.

Bottom line

Workers have a few 401(k) rollover options, but the best decision focuses on your financial situation, and the right rollover will differ from person to person. Also key is avoiding tapping your retirement funds, if at all possible, because you’re stealing from your financial future.

— Bob Haegele contributed to an update of this story.