During normal times, workers might leave their employer for a variety of reasons. These retirement savers would do well to consult with a financial adviser about their 401(k) options when leaving their job. With the onslaught of the COVID-19 pandemic, unfortunately many folks are losing their jobs, giving rise to the need for advice on their 401(k) options.
The main options are:
- Rolling the 401(k) over to an IRA at an outside custodian.
- Leaving the money in their old employer’s plan.
- Rolling the money over to a 401(k) with a new employer.
- Withdrawing some or all of the money.
Rolling Over to an IRA
Rolling the 401(k) to an IRA allows financial advisers to work with their clients to integrate these assets into the investing strategy in place for a client’s assets held outside of their 401(k) plan in taxable accounts or IRAs they already have in place.
Rolling this money to an IRA will offer clients a wider range of investment choices, often with lower expenses than what was offered in their old 401(k).
For clients with designated Roth 401(k) accounts, rolling this money to a Roth IRA precludes them from having to take RMDs on this money when they reach age 72. In the case of a traditional 401(k) account it can be rolled over to a traditional IRA and left as a tax-deferred account to grow until your client’s retirement. If appropriate for your client’s situation, some or all of this money could then be converted to a Roth IRA.
Leaving the Money in the Employer’s Plan
This might make sense if the investments offered in this plan are solid, ultra-low cost institutional quality choices that advisers might not be able to replicate for their client elsewhere. Money held in a 401(k) plan is generally protected from the claims of creditors, leaving the money in the plan is a consideration for clients who may need this extra level of asset protection.
Rolling to a New Employer’s 401(k)
If the client is moving to another employer, rolling their 401(k) balance over to that employer’s plan can make sense. This will allow all of their 401(k) assets to be combined in one place, which can be convenient from an investment management standpoint. If the need for asset protection is an issue, this is a viable solution.
For clients who will be working when they reach age 72, they may be able to defer taking their RMDs if their employer has amended their plan to offer this to their employees.
Clients will need to confirm whether their new employers will accept this type of rollover. Advisers will want to review the new plan’s investment lineup to ensure that the investments offered represent solid, low-cost choices.
Withdrawing Some or all of the Money
Advisers generally counsel their clients against withdrawing their 401(k) assets when leaving their employer. Between the tax hit plus any penalties if they are under 59½, taking some or all of their account balance as a distribution can be quite expensive.
If a client is leaving their employer due to a layoff they might need some or all of this money to offset their loss of income. There are still some planning opportunities if this is the case.
If a client leaves their employer at age 55 or older, they can take a withdrawal from their 401(k) without penalty. They must leave their job during the year in which they reach age 55 or later. This is known as the rule of 55.
The CARES Act included several provisions that pertain to options for people to tap retirement accounts to deal with issues arising from the pandemic. One provision allows for eligible participants to take an early distribution of up to $100,000 in total across all eligible retirement plans. The 10% penalty for those under 59½ are waived. The money is still subject to taxes, but there is some flexibility here. There is a requirement that those utilizing this option must have been impacted by COVID-19 in some way.
The tax liability is spread over the next three calendar years. Alternatively, this provision allows a client to “recontribute” some or all of the amount taken over the next three years to avoid taxes on those funds.
An option to consider would be to roll their 401(k) money to an IRA account and utilize this provision with money from that account. If a client had already taken a distribution of this type from their 401(k), the recontribution may be made to any eligible retirement plan such as an IRA account.