Changing Jobs? Don’t forget these essential items!
Changing employers has become a fact of modern life. With median job tenure for Americans at 4.6 years, we can expect to have 5-10 job changes in our working lives.1 Each of these transitions comes with opportunities, including a complex set of choices for your accumulated retirement benefits. Choosing poorly can have far-reaching consequences, including tax issues that may not seem obvious. The rules are complex, but neglecting to understand your choices can cost you.
Follow this checklist to help you preserve your hard-earned benefits:
- If your job ended unexpectedly, file for unemployment benefits as soon as possible.
- Consider what you’ll be doing for health insurance. If you are laid off, you may be eligible to continue on your employer’s plan using COBRA coverage for 18 months.
- Make sure you understand the terms, expiration dates and tax issues related to any severance or SRP payments, stock options etc. Human Resources should be able to answer your questions.
- Meet with your financial planner to discuss the best way to supplement income if needed, and review your benefit options.
- If you have a loan against your 401(k) plan, find out what the plan rules require. Typically you must repay the balance within 60 days of termination, and prior to doing any rollovers. If you fail to do this, the loan amount will be deemed a distribution, incurring taxes and penalties.
- Consider what to do with your 401(k), 403(b) or other employer-based retirement plan.
There are many factors to consider when choosing among your options for a 401(k) or 403(b) plan.
- You can usually leave it where it is, depending on the balance. If you like the investment options that are offered and want to manage it yourself, this may be your best choice.
- You can roll it into your new employer’s plan if the new plan permits this.
- You can take a full distribution. This is usually an expensive option, as you will incur taxes (always) and penalties (if you’re under age 59 ½ ), and lose tax deferral on your funds.
- You can roll it into a self-directed IRA, which can be managed for you by a professional who may charge a fee, or you can manage it yourself. This allows you the greatest variety of investment options, but also means changes in some protections against lawsuits and bankruptcy. (See “Protecting Retirement Assets”).
After reviewing all your options, suppose you decide that you’d like to roll your account over into a self-directed IRA.
There are some important considerations to review before you begin:
- Unpaid loans need to be paid prior to a rollover.
- After-tax contributions can be rolled out into a Roth IRA. This is a new option following an IRS rule change in 2015, which can provide you with future growth that is tax-free.
- If there is life insurance held in the plan, it will have to be removed or “rolled out,” because it can’t be held in an IRA. Generally this is accomplished either by taking the policy as a taxable distribution (at fair market value less the basis), buying the policy from the plan for cash, or surrendering it to the plan for cash value. In the last instance you will be left without insurance coverage, so be sure to consider whether you are able to replace the coverage if you need it.
- You may need your spouse’s consent to do a rollover, or to take any form of distribution other than a joint and survivor annuity with your spouse. Check the rules of your plan.
- Direct rollover or 60-day rollover? In most cases you will save yourself a lot of trouble by using a direct, trustee-to-trustee transfer where you open an IRA to receive the rollover, or roll it into an existing IRA. Another type of rollover has the plan pay the funds to you as a distribution, and you have sixty days to put them into an IRA. There are several drawbacks to this approach: First, it’s easy to miss the deadline if paperwork is not in order, and if that occurs you have turned your entire 401(k) into a taxable distribution. Also the plan is required to withhold 20% and send it to the IRS as income tax withholding. You can replace the withheld funds with substitute funds, but again if your goal is to get the funds into an IRA to continue tax deferral, the safest and easiest route is a trustee-to-trustee transfer into an existing IRA.
- Consider Net Unrealized Appreciation (NUA). If you hold appreciated company stock in your retirement plan, you may be eligible for NUA treatment on the stock shares, which can save you on taxes. If you roll the shares directly into an IRA, then all the distributions from the IRA will be taxed at your ordinary income rate. If your shares qualify for NUA treatment, you can distribute the company stock into a taxable account and pay ordinary income tax on the stock’s cost basis only. Later when you sell the shares, you will be taxed on the realized capital gain. Since the tax rate for capital gain is lower than the top income tax rate, you may have considerable income tax savings by using this approach. To qualify for NUA treatment, you must have separated from service or be at least 59 ½, you must distribute your entire vested balance in one tax year, and you must distribute all assets from all retirement plans held with that employer.
Changing jobs can be a demanding transition. Still, it makes sense to take time to speak with your financial planner and tax advisor about some of your choices regarding benefits from your previous employer. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your particular situation with a qualified tax advisor.
- Bureau of Labor Statistics 2015
Source: This article was written by Margaret (Peggy) Stephan, CFP® – LPL Financial Advisor at Retirement Capital Strategies.