When you leave a job, one important financial decision is what to do with your 401(k) or other employer-sponsored plan. The answer isn’t always straightforward. Taxes, investment options, fees, withdrawal rules, employer stock and after-tax contributions can all affect which approach makes sense for your circumstances.
What Are Your Options for an Old 401(k)?
Depending on the terms of your plan and your circumstances, you generally have several choices:
- Leave the assets in your former employer’s retirement plan.
- Roll the assets into your new employer’s retirement plan, if the new plan accepts rollovers.
- Roll the assets into an IRA.
- Take a distribution, which may result in income taxes and in some cases, penalties, depending on your age and circumstances.
Each option has potential benefits, limitations and tax considerations. Before moving the money, it’s important to understand how each choice fits into your broader financial plan.
Should You Roll Your 401(k) Into an IRA?
Rolling an old 401(k) into an IRA can provide greater investment flexibility and make it easier to consolidate retirement accounts. But a rollover isn’t automatically the best choice.
Before moving your money, consider:
- Fees and expenses. Compare the costs of your employer plan with those of the IRA.
- Investment options. An IRA may provide more choices, while some employer plans offer attractive institutional investments.
- Consolidation. Combining accounts can simplify recordkeeping, beneficiary reviews and investment management.
- Access to your money. Employer plans and IRAs have different withdrawal rules, which can be especially important if you may need the funds before age 59½.
- Loans. IRAs don’t permit participant loans, so an outstanding 401(k) loan requires additional consideration.
- Creditor protection. Employer plans and IRAs can have different protections under federal and state law.
The right choice depends on more than investment selection. Taxes, cash-flow needs and your broader financial plan should also be considered.
Before You Roll Over a 401(k), Look at What’s Inside It
Before deciding what to do with your 401(k) account, understand what is actually inside it. A 401(k) may contain:
- Pretax employee contributions
- Employer contributions
- Roth 401(k) assets
- After-tax employee contributions
- Employer stock
These assets don’t necessarily need to be treated the same way in a rollover. In particular, after-tax contributions and appreciated employer stock can create tax-planning opportunities that should be evaluated before moving the account.
Can You Roll After-Tax 401(k) Contributions Into a Roth IRA?
Potentially, yes. Traditional after-tax 401(k) contributions are different from Roth 401(k) contributions. When an eligible distribution contains both pretax and after-tax money, it may be possible to direct the pretax portion to a traditional IRA and the after-tax contributions to a Roth IRA.
One important distinction: earnings attributable to after-tax contributions are generally considered pretax dollars. Those earnings can potentially be directed to a traditional IRA while the after-tax contribution basis goes to a Roth IRA.
Plan provisions and the structure of the distribution matter, so it’s important to coordinate this strategy before requesting the rollover.
What Happens to a Roth 401(k) When You Leave a Job?
Roth 401(k) assets can generally be rolled directly into a Roth IRA or, if permitted, into a designated Roth account in another employer plan. Roth IRAs and Roth 401(k)s have different distribution rules, including how the five-year holding period is determined, so these differences should be considered before completing a rollover.
Own Company Stock in Your 401(k)? Consider NUA Before Rolling It Over
If your retirement plan contains appreciated employer stock, net unrealized appreciation (NUA) may provide an alternative to rolling those shares into an IRA.
NUA is generally the difference between the plan’s cost basis in the employer stock and its market value when distributed.
Under qualifying circumstances, employer stock can be distributed from the retirement plan to a taxable brokerage account. Generally, the cost basis is subject to ordinary income tax when distributed, while qualifying NUA isn’t taxed until the shares are subsequently sold. When sold, the NUA portion is generally taxed at long-term capital-gains rates rather than ordinary income-tax rates.
That potential difference in tax treatment may make NUA worth evaluating when employer stock has appreciated substantially. NUA isn’t appropriate in every situation, and specific requirements must be met. Your cost basis, tax rates, diversification needs and overall financial plan should all be considered. Importantly, NUA should generally be evaluated before rolling employer stock into an IRA.
Direct Rollover vs. 60-Day Rollover: What’s the Difference?
A direct rollover moves eligible retirement assets directly from your employer plan to the receiving IRA or eligible retirement plan. Generally, federal income tax isn’t withheld from the amount transferred.
With a 60-day rollover, the distribution is paid to you first. You generally have 60 days to complete the rollover, and eligible employer-plan distributions paid directly to you are generally subject to 20% federal income-tax withholding.
A direct rollover can be administratively simpler and avoids having the distribution paid directly to you.
A 401(k) Rollover Is More Than an Investment Decision
A 401(k) rollover may look like a simple administrative task after changing jobs, but the decision can affect your investments, taxes and broader financial plan. Employer stock, after-tax contributions, Roth assets, investment costs and future withdrawal needs should all be considered before moving the money.
At Core Wealth Management, our financial planners work alongside tax professionals to evaluate decisions like these within the context of a client’s broader financial picture. Rather than viewing your investments, taxes and financial plan independently, we believe they should be considered together.
Frequently Asked Questions About 401(k) Rollovers
What should I do with my 401(k) when I leave a job?
Depending on your plan, you may be able to leave the money with your former employer, roll it into a new employer’s plan, roll it into an IRA or take a distribution. The appropriate choice depends on factors such as fees, investment options, taxes, withdrawal needs and the types of assets held in the account.
Can I roll my 401(k) directly into an IRA without paying taxes?
Generally, eligible pretax 401(k) assets can be directly rolled into a traditional IRA without current income taxation. Rolling pretax assets into a Roth IRA, however, generally results in taxable income.
Can I roll after-tax 401(k) contributions into a Roth IRA?
Potentially. IRS rules may allow after-tax contributions to be directed to a Roth IRA while associated pretax amounts are directed to a traditional IRA or another eligible retirement plan. The transaction must be structured properly.
What is NUA in a 401(k)?
Net unrealized appreciation (NUA) generally refers to the increase in value of employer stock held in a qualified retirement plan above the plan’s cost basis. Under qualifying circumstances, the NUA portion may receive long-term capital-gains tax treatment when the shares are sold rather than being taxed as ordinary income.