What Clients Changing Jobs Should Know About Their 401(k)

Individuals who hold stock in the employer within a 401(k) plan can qualify for favorable tax treatment if the stock is left in the 401(k). After distribution from the 401(k) to a non-qualified account, a sale of the employer stock may qualify for taxation at the taxpayer's long-term capital gains tax rate under the net unrealized appreciation rules.

That's instead of the ordinary income tax rate that would apply to the appreciation on the stock if it was rolled into the IRA and later sold and the sales proceeds distributed.

Access to Retirement Funds

Many individuals have the choice to leave their funds within a former employer's plan or roll the funds into a new employer's 401(k) plan. One key consideration that is often overlooked involves whether the participant anticipates needing access to those funds.

Employer-sponsored 401(k) plans often contain loan options, structured to require repayment over a relatively limited period of time. When it comes to access to IRA funds, taxpayers can essentially borrow against their IRA for a 60-day period once in every 12-month period.

However, if a taxpayer plans to work past the age when distributions become mandatory (age 73), the taxpayer can avoid taking taxable required minimum distributions by leaving the funds in the employer-sponsored 401(k). Unless the plan requires earlier distributions, when participants continue to work and do not own 5% or more of the company, they can avoid taking taxable distributions from a 401(k). 

Distributions from an IRA must begin when the taxpayer reaches the required beginning date (currently 73), regardless of whether the taxpayer has retired. 

Typically, early distribution penalties apply if a taxpayer withdraws traditional retirement funds before reaching age 59.5. A taxpayer who leaves employment once reaching age 55 can withdraw funds from the 401(k) without incurring the 10% penalty for early withdrawals.

It may also be important to consider creditors' access to the retirement account funds. 401(k)s offer stronger protections against creditors in bankruptcy, whereas the amount of IRA funds protected in bankruptcy is always limited.

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