3784 / What should a taxpayer consider when deciding whether to roll funds from an employer-sponsored 401(k) into an IRA?

For a taxpayer who has reached age 55, but has not yet reached age 59½, the tax advantages of allowing the funds to remain in the 401(k) are clear. If the taxpayer were to roll the funds into an IRA, a 10 percent penalty tax would apply to any withdrawals made before the taxpayer reaches age 59½ (in addition to the otherwise applicable ordinary income tax rate), unless another exception such as disability or a series of substantially equal periodic payments applies. A taxpayer who leaves employment once reaching age 55 can withdraw funds from the 401(k) without incurring the 10 percent penalty for early withdrawals.¹

If a taxpayer plans to work past the age when distributions become mandatory (age 73), the taxpayer can avoid the required distributions by leaving the funds in the employer-sponsored 401(k). Unless the plan requires earlier distributions, as long as the taxpayer continues to work and does not own 5 percent or more of the company, he or she can avoid taking distributions from a 401(k). Distributions from an IRA are required to begin when the taxpayer turns 73, regardless of whether he or she has actually retired.²

Further, if a taxpayer holds stock in the employer within the 401(k) plan, the taxpayer may 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, rather than 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.