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Wealth Planning

Options for your 401(k) when you leave a company

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 worthy variety of investment choices, affordable fees, good administration—then you may want to stay in that plan. If your choices in your new employer’s plan are better for you—lower costs, bigger selection, or more desirable investment choices— you can consider rolling over your 401(k) into the new plan.

If you’d rather have the flexibility of managing your assets outside of an employer-sponsored plan, you could roll them into an IRA.

While you also have the option of taking a lump-sum distribution, the money that is distributed (other than after-tax contributions if you made any) will typically be included in your ordinary income at that time in most circumstances, reducing your wealth by the amount of tax you pay. We generally do not recommend this strategy, although your individual situation may vary.

If you have after-tax money in your 401(k)

The IRS allows you to separate your pre-tax money and after-tax money when you roll your 401(k) into an IRA. If you’ve made after-tax contributions to your 401(k), you can put your after-tax money into a Roth IRA and your pre-tax money into a traditional IRA—without having to pay any immediate tax. Note that in this example, the income and appreciation of your after-tax contributions are put into a traditional IRA in order to avoid immediate income tax.

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.

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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 distribution of your company stock out of the retirement account and transfer the stock to 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 accountant 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.

Expanded investment selections within IRAs

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 record-keeping 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, state law will determine the level of protection from other types of judgement. If you are going to roll your 401(k) to an IRA, it may be advisable for recordkeeping purposes to have a separate IRA for the rollover amount, instead of adding to an existing IRA.

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 advisor before making any decisions.  Your J.P. Morgan Advisor can help put your strategy in place.

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