Advising Clients on Old 401(k) Accounts

Clients seek advice on the best options for managing 401(k) accounts from previous jobs.
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With people changing jobs many times over the course of their careers, it is likely that your clients will eventually have several old 401(k) accounts to deal with. They will look to you for advice as to the best options for managing these key retirement funds.

Roll Over to an IRA

This can be a solid choice for many of your clients. This can be a good way to integrate these funds into the investment strategy that you already have in place for your client’s investments. In many cases, you will be able to invest these retirement assets into a better, lower-cost mix of investments than the client might have available in their former employer’s 401(k) plan.

If the old 401(k) is in a designated Roth account, it will generally make sense to roll that portion into a Roth IRA account. Roth 401(k) accounts are subject to required minimum distributions; Roth IRAs are not, so for clients nearing the age when RMDs come into play, this is especially key.

Use Net Unrealized Appreciation

Some clients might hold shares of their employer’s stock inside of their 401(k) plan. For these clients you might consider taking advantage of a set of rules within the tax code called net unrealized appreciation or NUA.

The NUA rules allow your client to take a distribution of the shares in-kind into a taxable account. They can still roll the balance of the 401(k) account that isn’t invested in the company shares to an IRA to maintain the tax-deferred nature of the account.

The NUA treatment entails paying taxes on the cost basis of the shares. They can then be held and sold at a later date. The potential advantage is that if held for at least a year after the distribution, the gains will be taxed at preferential capital gains rates, versus at ordinary income rates if the shares were rolled over to an IRA and then later withdrawn from the account in retirement.

The entire account must be distributed within the same calendar year for the NUA rules to apply.

Whether NUA is the right strategy for clients with shares of employer stock in their 401(k) is an analysis that will need to be done on a case-by-case basis.

Leave the Money in the old Plan

This might be a good option for your client in some cases. For example if the plan offers a solid menu of low-cost institutional quality investment options that you might have trouble replicating for them outside the plan, leaving the money there might be a good option.

In general though, it is probably a good idea to move the money to a new destination when the client leaves their employer.

Roll the Money Into new Employer’s Plan

If your client is moving to another job it may make sense to roll their 401(k) funds over to the new employer’s plan. There are a number of reasons this might make sense.

If your client is working and approaching the age when required minimum distributions come into play, this can be a way to defer RMDs on this money. If their new employer’s plan has elected this option, they can defer RMDs on the money in that plan if they are still working and not a 5% or greater owner of the company.

If your client will be doing a Roth IRA conversion, having this money somewhere other than in a traditional IRA account can potentially be advantageous from a tax standpoint for the client when doing the conversion.

Moving the funds here will allow some degree of consolidation of the client’s retirement funds versus leaving them in the old plan, it is one less bucket of money to oversee for you and the client.

A big part of the decision will be the quality of the investment in the new employer’s plan as well as the plan’s expenses.

Early Distributions at age 55

For those clients who are at least 55 and younger than 59½, there is an IRS provision that allows for penalty-free distributions from an old employer’s 401(k) if certain provisions are met.

The “rule of 55” can be used if your client leaves their job no earlier than the calendar year in which they reach age 55.

This applies to employees who voluntarily leave their jobs or who are laid off or fired, and this opportunity applies to both 401(k) and 403(b) plans.

This is limited to the assets in the plan of your current employer, it cannot be used for a 401(k) plan of a prior employer.

If your client knows that they will be in this position prior to age 59½, this could point to the option of rolling any old 401(k) money over to their current employer’s plan if they’d like to have access to those funds for a penalty-free distribution.

These early distributions will still be subject to any applicable income taxes.