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Plan Well, Retire Well

Saving and investing your money

Transitions: Strategies for your 401(k)

Deciding what to do with your 401(k) when you leave your job could be one of your biggest financial decisions. Same goes if you have a 403(b), 457, SEP or SIMPLE plan.

I'm hoping you already know that, unless you absolutely can't put food on the table without it, you do NOT want to cash out your 401(k) or any other retirement plan when you leave your job. You got that, right?

And perhaps you've already investigated the leave it in your old plan – transfer it to your new plan – roll it over to an IRA decision. If not, check out the pros and cons of those options in two of my earlier posts on What to do with your IRA: Consider costs, investments, and services and Think about when you want your money.

But there's still more to think about regarding strategies for your 401(k).

If you'll receive a few more paychecks before you leave

Strategy #1: Stop contributions to your 401(k), resulting in more take-home pay. Open a savings account and set up an automatic transfer of the additional money in your paycheck, so that it gets moved from your checking account into the new savings account each payday. DON'T leave the extra money in your checking account, because it will be too easy for you to spend it there.

Why: If your emergency fund is small to nonexistent and you don't have a new job lined up, you're going to need cash to live on. If you tap your 401(k) for that money and you're not yet age 55, you'll pay not only regular income tax but also an additional 10% early withdrawal penalty. (The normal rule is that you must be age 59 ½ to avoid the penalty, but "separating from service" when you're 55 or older avoids the penalty.) Because of the penalty, stopping contributions is a cheaper way to get access to cash than withdrawing money that's already in your 401(k).

Strategy #2: Do the opposite of Strategy #1: INCREASE your 401(k) contributions. Depending on your plan, your contributions might be limited to 20% of your paycheck or as much as 80%, as long as you don't exceed the annual dollar limits: $18,000 if you're under age 50, or $24,000 if you're 50 or over. Just be sure to leave enough in your check to cover health insurance premiums, Social Security, Medicare, any other deductions, and the income tax on the income not going into your 401(k). You may also be able to contribute to your 401(k) out of payments for unused vacation, sick, or personal days – but not out of a severance payment.

Why: Maybe you have a nice emergency fund, so you're not worried about having money to live on after your job ends. Maybe you're going to be getting a substantial severance payment, and you're concerned that it will bump you into a higher tax bracket for this year. Or, you simply expect that you'll be in a lower tax bracket in the future, so you'd rather defer as much income and taxes as possible. Reducing your taxable income this year makes sense.

To learn about tax brackets, check the income ranges for tax brackets for 2016 or read my explanation of how marginal tax brackets work.

If you have company stock that has increased in value in your account

Strategy #3: Do NOTHING with the money in your 401(k) until you get advice from a financial planner or tax professional who is knowledgeable about handling net unrealized appreciation (NUA) on company stock inside retirement plans.

Why: You have a one-time opportunity to treat the stock's appreciation as capital gain, at a much lower tax rate, instead of ordinary income at it's higher rates. But you'll need someone to crunch the numbers to see whether that's the best option in your case; rolling over to an IRA could still be better. To get the special treatment on the stock's appreciation, you must take everything out of your account in one year in a lump sum distribution. If you've already taken distributions from the account, you've probably missed your chance. When you take the stock out of the plan, you'll pay ordinary income tax on just the amount you originally paid for the stock. When you sell it, all the gain will be taxed at the lower, capital gains rate.

If this will be a low income year

Strategy #4: Pull taxable income from future years into this year, by converting some of your 401(k) into a Roth account. Then, your distributions down the road will be tax-free. The entire amount you convert will be taxable income, unless you had non-deductible (aka after-tax) contributions in the plan. If your plan offers both traditional and Roth options, you can convert to the Roth option inside your plan. If not, you can convert it by moving it into a Roth IRA.

Why: If you'll be in a lower tax bracket after you leave your job AND you have the money to pay the tax bill on the conversion, converting to a Roth make use of your lower tax bracket. Maybe you're retiring, but you don't plan to start taking Social Security for a few years. Or you're being laid off and this year's income will be low, but you hope to be back at work by the next year. In either case, your tax bracket may be lower this year than it will be in the future. You may be able to take additional income this year and pay tax at a lower rate than if you received that taxable income in the future. However, this strategy usually only makes sense if you have the cash to pay the taxes on the conversion. If you'll have to take money out of the plan to pay the taxes, it's probably not worth it.

If someone has approached you to offer advice

Strategy #5: Understand the motivations of anyone who is giving you guidance about what to do with the money in your account or where to move it.

Why: What to do with your 401(k) is a high-stakes decision; you want to get it right. Financial advisers who are also salespeople may see this as an opportunity to make some money for themselves. If you invest your money in their products, they could earn a nice commission. The challenge is to be sure that you're getting advice from someone who not only says he has your best interests in mind, but who is also legally required to put your interests first. Learn more on our website, Choosing a Financial Professional.

Things can get even more complicated if you borrowed money from your 401(k) and you haven't yet paid it all back. To give that thorny issue the attention it deserves, I'll handle that situation in my next post.


This post is part of a series about the decisions faced during a job transition, whether you're being laid off, retiring, or moving to another job. The initial post lists some of the topics I'm addressing, as well as why I'm writing about this issue. You can find other posts in this series by clicking the category Job Loss on the right side of this screen. Or you can subscribe to our monthly e-newsletter, which provides links to all of our new blog posts.


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