Recently, I received a call from a friend who had just started a new job. After I congratulated her, she asked me what to do with her old 401(k).

Her question is a common one. A lifetime of employment with a single employer is exceedingly rare, and according to a survey from the Bureau of Labor Statistics, the average person held more than 11 jobs between ages 18 and 48.1 So, during your career, it’s pretty likely that you’ll have to decide what to do with an old 401(k). What are your options?

Cash it out

It’s tempting to see a newly available pool of money and immediately start thinking of that vacation you’ve been dreaming of or the car in your garage that’s starting to show some age. However, prematurely cashing out your retirement savings may be one of the worst financial decisions you can make.

In addition to derailing your long-term retirement goals, you’ll likely owe taxes and penalties. Traditional or tax-deferred funds will be taxable upon distribution, and you may be subject to an additional tax penalty if the withdrawal occurs before you’ve reached age 59½.

Designated Roth 401(k) contributions can be withdrawn tax- and penalty-free because they were made with after-tax dollars, but any earnings on those contributions would still be taxed and may be penalized if you withdraw them before you’re 59½.2

Leave it alone

Just because you’re leaving your job doesn’t necessarily mean your retirement savings need to leave too. In many cases, you’re free to maintain your old account as is, but you won’t be permitted to make further contributions, and some plan features, such as loans, may no longer be available. If your old plan offers low fees and access to lower-cost investment options, inaction may even be the best course of action.

However, if you’re approaching age 70½, you should be familiar with the rules for required minimum distributions (RMDs) from an employer-sponsored plan.

Take it with you

If your new employer offers a similar plan, you can usually do a direct rollover to the new plan. Consolidating assets in your new plan may be beneficial if it offers diversified and low-cost investment options, or additional features, such as advice options or access to loans. Plus, it may be easier to keep track of your progress toward long-term goals if all of your retirement savings are in one place.

Roll it over to an IRA

Rolling over the funds to an IRA will give you the greatest amount of control over your costs and investment options. Administrative costs for IRAs can also be lower than what you might pay as part of an employer-sponsored plan, and you’ll have your choice of financial institutions and investment options. There are a few things to consider with this option:

  • IRAs may offer less protection from creditors for retirement assets than employer-sponsored plans. Plans covered by the Employee Retirement Income Security Act of 1974 (ERISA), such as 401(k) plans, are typically shielded from creditors. While IRAs are generally protected in the case of bankruptcy, nonbankruptcy creditor protection can vary from state to state. It’s best to consult an attorney if this is a concern.
  • If you are (or will be) a high-income earner considering backdoor Roth contributions, you’ll want to consider the potential tax implications a rollover could have on future Roth conversions. Keep in mind that the value of all of your IRAs must be considered when determining the tax consequences of a Roth conversion.
  • If you’re retiring in the year you turn 55 or later, you may be able to tap into your 401(k) without incurring penalties, but this exception to the early withdrawal penalty doesn’t apply once you roll over funds from an employer-sponsored plan to an IRA. In an IRA, you may be able to withdraw some assets penalty-free for limited purposes.

Consider converting to a Roth IRA

If your career move means higher pay and an expectation of higher taxes going forward, now might be an ideal time to consider a Roth conversion, which you’d do by rolling your 401(k) directly to a Roth IRA. You’ll owe taxes on the converted amount in the year you do the conversion, but distributions will be tax-free, and a Roth IRA provides additional flexibility and tax diversification.3

Make a decision that works for you

As with many financial decisions, there’s not one right answer, and the best course of action largely depends on the plan options you have available and your personal circumstances. Be sure to contact your old and new employer first to evaluate all of your options and plan features. Then you can compare plans with your IRA options and consider the costs and benefits associated with each.

The key driver of the decision should be based on factors you can control: keeping costs as low as possible and maintaining a well-diversified portfolio that’s consistent with your long-term goals.

Special thanks to my colleague, Jonathan Kahler, for his contributions to this blog.

1 Bureau of Labor Statistics, 2015: Number of Jobs Held, Labor Market Activity, and Earnings Growth Among the Youngest Baby Boomers: Results from a Longitudinal Survey. USDL-15-0528 available at bls.gov/nls.

2 Distributions received before you’re age 59½ may not be subject to the 10% federal penalty tax if the distribution is due to your disability or death; is distributed by a reservist who was ordered or called to active duty after September 11, 2001, for at least 180 days; is part of a series of substantially equal periodic payments taken under IRS guidelines; or is for certain unreimbursed medical expenses, an IRS levy, or if you left your job during or after the year you turned age 55.

3 Withdrawals from a Roth IRA are tax-free if you are over age 59½ and have held the account for at least five years; withdrawals taken prior to age 59½ or five years may be subject to ordinary income tax or a 10% federal penalty tax, or both. (A separate five-year period applies for each conversion and begins on the first day of the year in which the conversion contribution is made.)