Take Your Money With You: 5 Reasons To Rollover Your 401(K) When Leaving Your Employer

For employees, the end of the year doesn’t always ring in holiday cheer. For many employees, especially here in California where I’m based, longtime workforces know all too well that the year’s end also means layoff season.

Just this week I was speaking to an employee group about workplace optimism, when an employee pulled me aside afterwards and asked if we could set up some time to discuss a “package offering.”

The “downsizing” trend seems to be picking up speed, at least here in California. The state’s Employment Development Department reported that, in the June quarter, 253 companies filed government-mandated “WARN Act” layoff notices,  impacting 18,875 employees around the state. Over the past year, that’s 38% more planned cuts hitting 13% more workers.

For years I’ve worked with employees from companies such as SBC, Boeing, Dreamworks and many others and helped their employees navigate the move from employee to free agent from a financial planning standpoint.

One of the most important decisions anyone facing a layoff or considering taking a buyout involves the 401(k), the retirement savings plan that has largely replaced traditional pensions in most companies.

If you are leaving your company for any reason, you will need to decide what to do with the 401(k) you amassed while you were there. You have four options:

1. Leave all or part of your savings in the plan of your soon-to-be-former employer
2. Transfer assets to the plan of your new employer
3. Roll over the funds into an IRA
4. Cash out but pay an early withdrawal penalty of 10% if you are under age 59 ½ and income taxes.

Saying no to option 4 should be a no-brainer, given the taxes and penalties that would eat into your nest egg.  But choosing among the other three options can be tricky. Consider the following:

• Fees and expenses: Many large 401(k) plans offer low-cost options that have been carefully vetted by the plan’s administrators, but other 401(k)s are hobbled by underperforming funds and high costs. And even low-cost plans may charge former employees higher administrative fees if they choose to keep their 401(k) with the company.
• Investment options: An IRA may offer a more diverse investment selection than a typical 401(k) plan offers.

• Control and Simplification: Doing a rollover of all your funds when you leave a company makes managing those funds a lot easier and gives you flexibility and the ability to consolidate accounts and make adjustments for age and changes in your tolerance for risk.
• Ability to withdraw: About two-thirds of large 401(k) plans allow retired plan participants to take withdrawals in regularly scheduled installments—monthly or quarterly, for example—and about the same percentage allow retirees to take withdrawals whenever they want, according to the Plan Sponsor Council of America, a trade group. Even if your 401(k) plan allows regular withdrawals, an IRA could offer more flexibility. Many 401(k) plan administrators don’t let you specify which investments to sell; instead, they take an equal amount out of each of your investments.
• Required minimum distribution and Roth opportunity: When you reach age 70 1/2, you must begin taking required minimum distributions (RMDs) from your 401(k), even if it is a Roth 401(k). One option to avoid RMDs is to convert your 401(k) to a Roth IRA. It must be a Roth account because traditional IRAs also have RMDs. Note that if you’re going to do this, you’ll be expected to pay taxes on the converted funds in the year of the conversion — unless you’re converting from a Roth 401(k) to a Roth IRA, as these are both funded with after-tax dollars.

• Another consideration: The tax code allows special tax treatment of company stock under “net unrealized appreciation” rules that can potentially save you a lot of money, especially if the stock has grown in value since you acquired it.  You may wish to consider the net unrealized appreciation (NUA) strategy to determine whether it would enable you to potentially save significantly on taxes. This is a complicated calculation, best made with the advice of a tax attorney or a qualified financial advisor.