To Rollover or Not to Rollover

Pros and Cons of keeping your nest egg in a 401K vs rolling it over to an IRA

Congratulations, you’ve left your current employer! Maybe it was your choice… or maybe not. Either way, before getting too comfortable in your chaise lounge by the pool, you should decide what to do with your 401K stash.

You have choices: leave it where it is, with your old employer, or roll it over. You may either roll it over into your new employer’s 401K (if they allow it), or an IRA.

The IRS provides a lovely chart on what types of accounts can be rolled into what other types of accounts:

Let’s break down the pros and cons:

Stay in a 401K

Either leave the money in your old employer’s 401K (or other Plan) or roll it over to your new employer’s 401K (or other Plan). This decision may ultimately rest on how you like the Plans you are presented with.

However, the biggest reason to keep your money in a 401K is ERISA protection. ERISA is the Employee Retirement Income Security Act passed in 1974. ERISA protects not just 401Ks but many types of defined benefit and defined contribution plans.

Under ERISA, if you are sued or creditors come after you, the money in your 401K cannot be touched

The only way your money can be taken by others is either by the IRS or via a Qualified Domestic Relations Order (QDRO), such as in the case of divorce.

IRA’s have some protection, but they are covered under a different set of laws, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (PAPCPA). Your IRA savings up to a certain limit may be safe if you declare bankruptcy, but otherwise, creditors and others can go after it. That limit is around $1.3 million dollars at present.

(Note, if you inherited your IRA, it’s not protected at all.)

So, if your life is a bit “complicated” you may wish to keep your money in an employer Plan.

Rollover to an IRA

Most of us are not at risk of either litigation or bankruptcy, so rolling over the money to an IRA is a good option.

The big advantage of an IRA is control. If you keep your money with an employer 401K, you are stuck with the limited choices presented to you. These plans famously have a limited number of investment choices; perhaps only three: stock, bond, and a money-market fund. If you are a buy-and-hold index investor, this might be just fine.

Another consideration is the fees. Your 401K might be charging you higher fees than you can get elsewhere. You may need to dig into the fine print to determine this.

Once you decide to make the switch, you can roll your money over to virtually any financial institution that supports IRAs. I currently keep my own IRAs at an institution where I can buy ANY stock, bond, ETF, or mutual fund available to the public. I like the choice.

Taking money out late — Required Minimum Distributions

Upon reaching age 70½ (specifically, the April following the year you turn age 70½) you are generally required to take Required Minimum Distributions (RMDs) from your 401K accounts and IRA’s. The IRS is graciously letting your savings grow tax-free, but they want their cut eventually. RMDs are calculated by dividing your stash by a factor, which approximates how many more years the IRS thinks you are going to live. Mathematically, RMDs allow the IRS to effectively tax all your money before you die.

For example, let’s say you are 71 and have $1 million saved in tax-advantaged accounts. Your factor is 26.5 because the actuaries that work for the IRS believe your life expectancy (plus a spouse) is age 97 (71+26.5). You are required to take a distribution of 1M/26.5 = $37,736 this year, transferring this money to a regular taxable account and paying the taxes.

Depending on your cash flow needs at age 70½, RMDs might not be an issue. However, if you wish to keep that money growing tax-free, the location of this money becomes important.

If you are still working (yes, at age 70½), you do not need to take RMDs from your current employer 401K. However, you still may need to take RMDs from your IRAs and any old employer 401K.

Note, that if you own more than 5% of the company, ie, you are self-employed, you still must take RMDs out of your employer Plan. Also, this RMD exception is completely up to the discretion of your employer; they may require everyone over age 70½ to take RMDs, employed or not.

If you are retired, upon reaching age 70½, you’ll need to take RMDs from a Roth Account within a 401K or other plan.

However, if your Roth money is sitting in a Roth IRA, no RMDs are required

In summary, from an RMD perspective, roll over your Roth money to a Roth IRA, but if you plan to work past age 70½, roll over traditional money into your next employer’s 401K.

Taking money out early — prior to age 59½

Hopefully, this isn’t the case, but there may be times you need to take money out prior to turning age 59½. Most of the rules for taking penalty-free distributions are the same for both 401K and IRA accounts, but there are a few notable exceptions.

If you “separate from service” after age 55, you may take distributions from your 401K penalty-free. However, if you roll this money over into an IRA first, you will no longer be able to do this.

But if you’re retiring early, both 401Ks and IRAs allow payments to be made in “substantially equal periodic payments” for five years or until age 59½, whichever is later.

Unlike 401Ks, you can take money out of IRAs, penalty-free, for the following:

  • Qualified higher education expenses. These are for either you or someone else and cover tuition and fees at a college, university, trade school, or other post-secondary education (eligible for federal student aid).
  • Qualified first-time homebuyer, up to $10,000
  • Health insurance premiums paid while unemployed

But it should be obvious that it’s better NOT touching your IRA for these expenses if you can manage it. Once you take this money out, you can’t put it back. Instead, let your savings grow in a tax-free environment for as long as possible.

Don’t co-mingle

You probably already have an IRA account or two where you’ve been diligently making annual contributions over the years. You can roll over your 401K money into this account, but it’s wise not to. Instead, set up a separate account for you 401K money; it can even be at the same institution.

There are two reasons for this. First, if you decide later that you like your new employer’s 401K plan you have the option of rolling the funds back. However, if the account is “comingled” with IRA contributions you won’t be able to do this.

Second, with regard to ERISA, a “Rollover IRA” exists in a legal grey area. If you get yourself in trouble with creditors, depending on your state and the judge, your money might be protected as if it was still sitting in a 401K. Maybe.

Direct vs Indirect

There are two ways to do a rollover. The easiest and recommended way is the direct way. Once you’ve set up an IRA account at your favorite financial institution, call up the institution where your money currently resides and ask them to implement a direct rollover. They will send your favorite institution a check. You never touch the money.

Alternatively, you can have the check sent to you. Now you have exactly 60 days to deposit that money with your favorite institution, or penalties will apply. (If you miss the deadline, you may be able to convince the IRS to give you a pass, but don’t count on it.)

One important caveat. When the check is sent to you, taxes will be removed. But when you deposit that check in the rollover account you need to add the taxes back, so the balance equals the original amount. You aren’t getting those taxes back until you file your tax return early next year, so you’ll need extra cash on hand.

The only reason you might consider an indirect rollover is if you need to “borrow” that money during that 60-day window. Perhaps you’re buying a new home before selling the old one and need down-payment money.

Note, you’re only allowed one indirect rollover per year, so creative “borrowing” is limited.


In summary, keeping your money in one tax-advantaged account vs another won’t make much of a difference. The tax-free growth is the most important thing.

However, given a choice, the biggest incentive to leaving your money in a 401K is protection afforded by ERISA. The biggest incentive for rolling your stash into an IRA is control, both with regard to individual investments, as well as the fees. If you plan on retiring earlier, or later than usual, there are additional considerations based on your cash-flow needs. Also remember, only Roth IRAs are completely exempt from RMDs, as every other type of account will be affected.


Disclaimer: This information has been provided for educational purposes only and should not be considered financial advice. Any opinions expressed are my own and may not be appropriate in all cases. All efforts have been made to provide accurate information; however, mistakes happen, and laws change; information may not be accurate at the time you read this. Please seek out a licensed professional for current advice specific to your situation.

Making of a Millionaire

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Liz Baker

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Liz Baker

Scientist nerd, and champion of medicine, personal finance, and innovation. Using knowledge to empower others to succeed in life. Or simply enjoy kittens.

Making of a Millionaire

Publishing Stories on all things related to personal finance