401(k) Rollover Options Upon Job Change or Loss

Possibly the very best feature of a 401(k) is that your account balance is portable upon job loss or job change. The same is true in the event that your employer goes out of business. This was a revolutionary concept when 401(k) plans were first introduced in 1978, in the days when job loss or business closure likely meant the forfeiture of all future pension proceeds.

We will discuss here the two most common forms of employer-sponsored retirement savings plans, the Traditional 401(k) and the Roth 401(k). Rollover rules are similar between the two, so we’ll start with the Traditional 401(k) and then discuss the differences that apply to the Roth 401(k).

Choosing the Correct Rollover Method

Before we discuss the 401(k) rollover options, it is important to discuss the two ways that funds can be moved from one qualified plan to another (including to an IRA account). The IRS has established a “60-day rollover rule”, meaning that once funds are removed from the original 401(k), they must be moved into another qualified retirement account within 60 days to maintain their retirement account status and to avoid penalties and taxes.

Direct Rollover Method

The first and most favored method is the direct rollover method. With this method, a new 401(k) or IRA is first established with a new administrator for the receipt of transferred funds. The administrator of the new account will work directly with the administrator of the original 401(k), Roth or Traditional, to orchestrate an institution to institution transfer. In this way, the account holder never receives the funds and is in no jeopardy of missing the 60-day window.

Payment to Account Holder

The second and more complicated method is for the account holder to receive a check payment for the proceeds in the original account with the responsibility to have a new 401(k) or IRA set up to receive a deposit of these funds prior to the 60-day deadline. Adding complexity, the administrator of the original 401(k) is required to withhold 20% of the account balance for the potential payment of taxes and penalties should the 60-day deadline not be met.

What this means is that the account holder must not only deposit the 80% of the account balance received as a check payment into the new qualified plan or account, but must come up with the other 20% on their own, from their own savings, and deposit this amount, too, in order to reach the full balance prior to the 60-day deadline. The 20% withheld by the prior plan’s administrator will eventually be returned either by check or via the income tax withholding process, but it won’t be sent directly to the new account prior to the 60-day deadline.

Clearly, the direct rollover method is the preferred method.

Five Options for a Traditional 401(k) Upon Job Change or Loss

There are five options for the Traditional 401(k) assets upon job loss or job change. Three of these options involve rollovers to another retirement account and two do not. The are listed as follows and discussed separately below.

• Keep assets where they are in the current 401(k).
• Roll over assets to a new 401(k) with a new employer.
• Roll over assets to a Tradition IRA (new or existing).
• Roll over assets to a Roth IRA (new or existing).
• Take a cash distribution.

Keep Assets Where They Are in the Current 401(k)

Under certain circumstances (most commonly being that you have at least $5,000 in the account) your account balance can simply stay within the current 401(k) plan of your former employer. You will no longer be able to make contributions to this plan. The account stays subject to the same rules as before, with the same administration fees and same investment choices, withdrawal options, and hardship withdrawal options. Loan options will not be possible as there is no “paychecks” to repay the loan.

Advantages to this option are:

• You still have the option to roll over funds in the future.
• You may like the investment options in the current plan.
• This plan may have lower administration fees or investment fees than alternatives.
• If you’ve left or lost your job between the ages of 55 and 59 1/2, you may qualify to take penalty-free withdrawals.

Disadvantages to this option are:

• Your investment options may be better elsewhere.
• Administration fees and other expenses may be lower elsewhere.
• Maintaining multiple retirement plans and accounts can be complicated to manage especially if you move, change your name, the company is bought or sold, or the company changes plan administrators.

Roll Over Assets to a new 401(k) with a New Employer

Obviously, this option is only available to those who have, a) found another job, and, b) the new employer offers a 401(k) plan. When eligible, this allows you to move all assets from your old plan into the new plan, keeping your retirement assets in fewer places. This option is most likely done when the new plan has more favorable features compared to the old plan, or in the event that you didn’t qualify to keep assets in the old plan.

Advantages to this option are:

• You may have access to better investment options in the new plan.
• The new plan has better features for loans and other withdrawals.
• The new plan may have lower administration fees and other expenses.
• You avoid having retirement savings spread over multiple accounts.

The disadvantages would simply be the opposite of the advantages, in that the old account has better features across the board than what’s available in the 401(k) plan of the new employer.

Roll Over to a Traditional IRA

Instead of keeping assets where they are or rolling them into a new employer’s 401(k) plan, you may instead roll over your retirement assets into a newly created or pre-existing Traditional IRA. Assets would continue to grow tax-deferred as they did in the Traditional 401(k).

Advantages to this option are:

• If chosen carefully, a Traditional IRA account can offer many more investment options than a 401(k).
• You can consolidate several retirement accounts into a Traditional IRA for easier account management.
• You IRA provider may offer lower administration fees and other expenses associated with the account.

Disadvantages to this option are:

• You can’t borrow against an IRA like you may be able to in a 401(k).
• You may have less protection from creditors with an IRA than you have with a 401(k).
• Some IRAs may offer fewer investment options, rather than more.
• In the event that you held company stock in the old 401(k), rolling over company stock into an IRA may have negative tax implications.

Roll Over to a Roth IRA

A rollover with a conversion at the same time from a Traditional 401(k) to a Roth IRA may be an option, though will be subject to taxes and, as such, it is best to consult a tax professional or independent financial advisor to discuss this strategy in detail.

Advantages to this option are:

• You will no longer be required to take required minimum contributions starting at age 70 1/2.
• You will no longer pay taxes on properly made withdrawals during retirement years (though may have paid taxes at the time of the rollover).
• See all the advantages listed above for a rollover to a Traditional IRA.

Disadvantages to this option are:

• Any Traditional 401(k) assets rolled into a Roth IRA will be subject to taxes at the time of conversion.
• See the list of disadvantages above when rolling assets to a Traditional IRA.

* Note that this process is essentially the same as converting your Traditional IRA to a Roth IRA with all the same implications, just done at the same time as the rollover process.

Take a Cash Distribution

Taking a cash withdrawal will expose you to the risk of taxes and penalties, which could be substantial. You will have lost your retirement savings as well as the tax-preferential treatment of assets held in retirement accounts. This option might be best considered for emergencies only, such as the inability to find other work after a job loss. It would be critical to consult with a tax professional or independent financial advisor before making this decision.

Rollover Considerations if the Old Account was a Roth 401(k)

Roth 401(k) assets cannot be rolled over or converted into either a Traditional 401(k) or Traditional IRA. As with the Traditional 401(k), they may be kept within the plan of the old employer, subject to meeting requirements. Assets may be taken as a cash distribution and will be subject to a different set of taxes and penalties, those relating to Roth 401(k)s.

Otherwise, there are two basic rollover options. First, assets can be transferred to a Roth 401(k) plan with a new employer, if available. Or, assets can be transferred to a Roth IRA, either newly created or pre-existing. Done properly, no taxes or penalties will be incurred and the assets retain the same tax-free features of the Roth variety of retirement accounts.

One important consideration remains, and that is related to the five-year “seasoning rule” for Roth accounts. Though contributions can always be withdrawn tax-free and penalty-free at any time and at any age, earnings within the account cannot be withdrawn tax-free or penalty-free until the account has been open for at least five years.

Five-year Holding Rule for a Roth 401(k) to Roth 401(k) Rollover

If a full transfer of Roth 401(k) assets is made from a Roth 401(k) that has already met the five-year holding rule, then assets in the new Roth 401(k) will continue to have met the five-year holding rule. Note that the administrator of the old plan must contact the administrator of the new plan to provide supporting details. In the event of a partial transfer to a new Roth 401(k), transferred funds that may have previously met the five-year holding rule will lose this status, and a new five-year period must start again.

Five-year Holding Rule for a Roth 401(k) to Roth IRA Rollover

When assets are transferred from a Roth 401(k) to a Roth IRA, any five-year holding period for the Roth 401(k), whether met or unmet, is disregarded. The transferred assets take on the five-year holding period status of the Roth IRA that receives the fund.

What this means is that if the receiving Roth IRA has already met the five-year holding period requirements, transferred assets from a Roth 401(k) automatically also meet the requirement. If the Roth IRA has yet to meet the requirement, the five-year period for the transferred assets begins from the date that the Roth IRA was opened, regardless of how long they were held in the Roth 401(k).

Summary

Laws related to retirement accounts are complex and subject to frequent change. Rollovers, conversions and transfers between accounts are complex and may involve exceptions and details not covered in this article. It is always recommended that you discuss these matters with a tax professional or independent financial advisor to understand the latest rules and to learn what strategies are best for you and your situation.

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About the Author

Todd E. Frank, CPA/PFS, MBA is the President and CEO of Frank Financial Advisors, a Registered Investment Advisory Firm (RIA) serving clients nationwide from our headquarters in Carlsbad, San Diego, California. As an RIA, Frank Financial Advisors is able to offer truly independent, fee-only financial advisory services.