Adam Frank

Managing Director, Head of Wealth Planning and Advice, J.P. Morgan Wealth Management

If you are changing jobs, retiring or taking a break from work, remember that there are decisions to be made regarding your 401(k) if you have one.

What are your options?

In general, you have four choices with your 401(k):

  • Stay in your old employer’s plan
  • Roll over into your new employer’s plan if you are taking a new job
  • Roll your 401(k) assets into an IRA
  • Take a lump-sum distribution

Evaluate your choices before deciding. If your old employer’s plan has qualities you like – a suitable variety of investment choices, low fees, good administration – then you may want to stay in that plan. If the qualities of your new employer’s plan are better for you – lower costs,  or more desirable investment choices – you can consider rolling over your 401(k) into the new plan, if available. You also may want to roll over to your new employer’s plan in order to consolidate your assets into fewer accounts to reduce the administrative burden.

If you’d rather have the flexibility of managing your assets outside of an employer-sponsored plan, you could roll them into an IRA. An IRA may be the most flexible choice for you because you generally won’t be limited to the menu of investments available via a 401(k) plan. Additionally, you can consolidate your account with your other retirement accounts, if available, making recordkeeping easier.

However, if your overall cost is higher for an IRA than it would be with a 401(k) plan, make sure that the benefits you receive are worth any additional fees you might pay. IRAs also may not have the same level of creditor protection as 401(k) plans. Although rollover IRAs from a 401(k) may be protected in bankruptcy proceedings (up to a certain amount), state law will determine the level of protection from other types of judgements.

While you also have the option of taking a lump-sum distribution, the money that is distributed from a pre-tax 401(k) will typically be included in your ordinary income. If you choose a lump-sum distribution from a Roth 401(k), any earnings will not be included in your ordinary income for the year the distribution is made provided it’s a “qualified distribution” as defined by the Internal Revenue Code (among other things if the distribution is taken after the account has been open for at least five years and you are age 59 ½ or older). Additionally, a distribution from a pre-tax 401(k) or a non-qualified distribution from a Roth 401(k) may also be subject to an early withdrawal penalty. We generally do not recommend this strategy, although your individual situation and need for the assets may vary.

Also, keep in mind that different rollover strategies may be available if you have both pre-tax and after-tax money in your current employer-sponsored qualified retirement plan. Please contact your tax or legal professional with respect to the options available to you.

If you own company stock in your 401(k)

If you own your company’s stock in your 401(k), you may be eligible to take advantage of a strategy called “net unrealized appreciation,” or NUA.

Generally, if you roll your pre-tax 401(k) – including your company stock – into a traditional IRA, the transaction is tax-free. When you later take distributions from the IRA, the full amount of each distribution is taxable at your ordinary income-tax rate. The NUA strategy, however, allows you to apply potentially lower capital-gains tax rates to the gain in your company stock that you own in your 401(k).  This strategy is only available  when you leave your job, as we’re discussing here, or upon your death, disability or reaching age 59 ½.

How the NUA strategy works

To execute the NUA strategy, you would make two transfers from your 401(k): you would roll everything in your 401(k) other than your company stock into an IRA, and you would take a lump-sum distribution of your company stock out of the retirement account into a taxable account. At the time of distribution, only the stock’s basis (generally its cost) is included in your ordinary income. If you sell the stock immediately after you receive it from your 401(k), the difference between the basis and the then-current value of the stock will be taxable at long-term capital-gains tax rates rather than ordinary income rates. (If you hold the stock for a period of time before you sell it, the tax treatment is more complicated, and you should consult with your tax professional before executing the strategy.)

The NUA strategy won’t work in every situation, but it is possible that you could save a significant amount of tax if the circumstances are favorable. You should consult with your accountant or other tax professional if you have company stock in your current employer’s 401(k) plan.

The decision about how to manage your old 401(k) isn’t always straightforward and can have significant implications for your long-term financial strategy. Since everyone's situation is different, you should speak to your tax professional before making any decisions. A J.P. Morgan advisor can help put your strategy in place.

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