Though the rate of job change among STEM professionals is majorly impacted by life stage and field-specific considerations, current research indicates that the average American worker may change employers 12 times during their working life. In a 2024 survey, 47% of tech sector professionals indicated they were actively planning to seek new employment. Among other things, this means that a rising STEM professional, after 10–15 years of employment, may have worked for a number of different employers and could potentially have contributed to several different retirement plans.
Many of those who change jobs to accelerate income growth or promotion may not realize that they have several choices for what to do with their employer-sponsored plans when they change jobs. Some of these choices, in fact, can have major tax and other implications, either at the time of the job change or later (including at the time of retirement).
What are my options for an old 401(k) after leaving a job?
Moving to a new employer as a STEM professional presents you with several choices concerning the vested balances in the retirement plan sponsored by your previous employer. (By the way, many STEM professionals work for educational or other nonprofit employers who offer 403(b) plans instead of 401(k)s; the concepts presented here regarding 401(k) plans generally hold true for 403(b) plans as well; the rules for the 457 plans offered by some governmental and non-governmental entities may vary.) Typically, these options are:
- Cash out (not recommended);
- Leave the balances in the previous employer’s plan (subject to plan rules);
- Rollover to new employer’s plan (subject to plan rules);
- Rollover to an IRA.
Reviewing each option in turn, it’s important to say up front that simply cashing out a lump sum from your former employer’s plan is rarely in your best interest. First, the employer is typically required to withhold 20% of the balance for taxes, and unless you are age 59 ½ or more, you will owe a 10% penalty on top of any ordinary income taxes due on the amount. Unless your need for cash is truly dire, this option is generally the least desirable and almost always the most costly.
Leaving your account with your old employer is often the simplest option, since you don’t really have to do anything. As long as your account balance meets the minimums required by the plan, you can simply allow the funds to stay where they are, where they will continue to grow tax-free (in a Roth plan) or tax-deferred (in a traditional plan) until withdrawn. The disadvantages of this option include your inability to make further contributions to the plan and any limitations on access to other options (such as loans) mandated by the terms of the old employer’s plan. Some plans may also impose higher plan fees (“maintenance fees”) on accounts owned by former employees. Finally, leaving a plan with an old employer simply makes it easier to forget about, which may complicate your planning later on (for example, you may fail to include the plan balance in calculations for your required minimum distributions, incurring tax penalties).
Rolling the balance of your old account over to your new employer’s plan can be a good option, but there are several things to consider here. First (and perhaps most obvious), you should confirm with your new employer’s human resources personnel that the plan accepts such rollovers. Next, you should review the plan fees and other charges imposed by the new employer’s plan; if these are not competitive, you may wish to consider staying in the old employer’s plan or rolling your balance into an IRA. And again, you should consider the investment options offered by the new plan: Are they better than those offered by your old plan? Are they appropriate for your investment goals? Do their returns compare favorably with industry benchmarks? Does the plan offer appropriate administrative and educational support? Comparing costs and features can help you make a better decision for where to entrust your retirement savings.
Finally, you may decide to roll your account balance over to an individual retirement account (IRA). By doing this, your assets retain their tax-advantaged character, and often this also gives you more flexibility in investment options than may be available with either the old or the new employer’s plan. You can (and probably should) continue to contribute a portion of your earnings to the new employer’s plan, but you will still have the benefit of your rollover funds as they continue to grow and compound in a tax-advantaged environment. You should do a direct rollover, in which the trustee for your former employer’s plan transfers the funds directly to the trustee for your rollover IRA. A direct rollover has the advantage of allowing you to avoid any required tax withholding, since you never take custody of the funds yourself, and there are no limits on how many times it can be done in any given period. If a direct rollover is not possible for some reason and the funds are distributed to you, you can still roll them into an IRA using an “indirect rollover,” so long as you do it within 60 days, but you have to find the cash to make up for the taxes that will have been withheld when the old employer distributes the funds to you. In addition, this kind of 60-day rollover is allowed only once every 365 days, so it won’t be an option if you have already done one in the last year.
Can I roll a traditional 401(k) into a Roth IRA or 401(k)?
For some individuals, converting traditional (pre-tax) funds to Roth (after-tax) assets, known as a Roth conversion, can be advantageous. This can be accomplished by choosing to roll over pre-tax 401(k) funds to a Roth IRA or Roth 401(k). Because the funds deposited in a Roth account have been taxed, no tax is assessed on income withdrawn from a Roth account in retirement. Also, Roth accounts have no RMDs, which can give the account owner more control over when the funds may be withdrawn.
The important thing to remember is that when funds are converted from traditional to Roth status, taxes must be paid on those converted amounts. So, if you want to roll some or all of a traditional 401(k) over to a Roth IRA or a Roth 401(k) (“Roth conversion”), you will pay the taxes owed on those funds prior to the rollover. Often, those considering a Roth conversion will time the transaction to occur during a year when they may be in a lower tax bracket, in order to save on the taxes owed.
Alternatively, the pre-tax funds can be rolled into a Traditional IRA with no conversion, and no taxes will be due.
What should I do with company stock in my old 401(k)?
Some STEM professionals may find themselves in the position of holding highly appreciated company stock in a 401(k). Other than the problems that accompany holding a concentrated stock position, having highly appreciated stock in a retirement plan can also lead to tax-inefficient distributions in retirement. This is because when the stock in the retirement plan is liquidated and distributed, the proceeds are taxed as ordinary income, which is almost always taxed at a higher rate than the capital gains rate that would be applied if the stock were sold in a taxable account.
To avoid this, some individuals may opt for the net unrealized appreciation (NUA) approach. NUA may be utilized only when qualifying events occur:
- Separation from the company;
- Reaching age 59 ½;
- Disability;
- Death.
When the qualifying event occurs, the account owner takes an “in-kind” transfer of shares from the retirement account to a taxable brokerage account. At that time, the owner pays ordinary income tax on the original cost basis of the shares (typically, the original purchase price, though when shares are purchased at different prices over time, an average cost per share may be used). When shares are eventually sold, capital gains tax (0, 15, or 20%, depending on other income) is paid on the appreciated value (the difference between the cost basis and the market value at the time of the sale).
The Bottom Line: Know Your Options
As you can see, there are a number of considerations around the decision of what to do with an old 401(k) when changing jobs. Keep in mind these four important principles:
- Check the fees and other costs for both the old plan and the new plan;
- Evaluate the available investment options;
- Consider a Roth conversion;
- If you hold highly appreciated company stock, consider NUA.
