Understanding Severance Packages, Part 2: 401(k)

Whether it comes after a year, a decade or a whole career, being dismissed from your job is never easy. Routines are upended, relationships are disrupted, and your sense of identity may take a hit. Your next step could be a job in the same field, a new career path, an entrepreneurial project or perhaps even retirement. But while you think it over, you’ll also have some important financial issues to consider.

Welcome to the second article in a five-part series about severance-related issues that you should know about if you ever find yourself in this challenging position. Today, we discuss the potential impact on your 401(k). Each retirement investors situation is unique, so we recommend speaking with an advisor to discuss the options for your retirement investments.

Before you leave

A 401(k) plan tax-efficiently builds wealth for retirement and is often supplemented by matching employer contributions. Once your separation date is confirmed, it’s generally best to fund the maximum allowable amount to your 401(k) plan before that date. It’s a great retirement savings opportunity that will soon be lost, so take advantage of it while you can, as long as it makes sense for your financial circumstances.

If a paycheck adjustment that will reduce your take-home pay is needed before year-end, remember that you’ll be receiving a severance payment shortly after separation, which can offset part of this impact.

Some 401(k) plans provide the option of contributing on a traditional pre-tax basis or to a post-tax Roth 401(k). If all your contributions aren’t already being made on a pre-tax basis, switching any remaining contributions to traditional pre-tax can help you reduce your taxable income for the year.

What to do with your 401(k)

After leaving your company, you have a few options regarding your 401(k) plan. First, it might be possible to leave your account in the company plan as it is. Plan terms may vary, so please consult with your company to determine which options are available to you.

If you can keep your plan at the company, it will remain invested and continue growing and will continue growing on a tax-deferred or tax-free basis, depending on whether your contributions were pre-tax or Roth. You may also continue accessing your account on the 401(k) website. You won’t be required to withdraw funds from your account until you reach age 73, when the IRS requires that distributions begin.¹

If you’re between the ages of 55 and 59 ½, consider whether you might need to withdraw from your 401(k) plan before age 60. Generally, withdrawals from a retirement account before age 59 ½ are subject to a 10% early withdrawal penalty. However, a special rule allows penalty-free withdrawals from your 401(k) prior to age 59 ½ if you’re at least age 55 during the calendar year that you separate from employment service.² As such, it might make sense to leave some or all of your 401(k) assets in the 401(k) plan just in case you need to withdraw some funds before age 60.

A second option is to roll over your 401(k) into another company’s 401(k) plan or an IRA and/or Roth IRA. The components of your 401(k) deposits will determine what type of account the money should be rolled over to while avoiding taxes. Generally,pre-tax dollars should be rolled over into a traditional IRA, with the check made payable to the IRA custodian. Any Roth 401(k) dollars should generally be rolled to the custodian of the Roth IRA.

Lastly, if you have an “after-tax account” where you made after-tax contributions over the years, consider rolling these contributions into your Roth IRA. It’s a unique strategy that many high-income earners can take advantage of, where funding a Roth IRA might not have been possible in the past due to IRS income limits. The after-tax contributions may also be deposited into your personal checking or brokerage account.

We’re here to help

Over the years, our team has helped many executives and professionals navigate the complicated and often overwhelming severance process. We’ll develop a personalized strategy, including investment recommendations, to help you make the most of your severance package and position your finances for long-term success.

Are you wondering what to do with your 401(k) and what rollover decisions might best suit your circumstances? Contact a Corient Wealth Advisor today.

Other topics in this series

• Part 1: Severance and deferred compensation
• Part 3: Stock awards and your investment portfolio
• Part 4: Insurance
• Part 5: Pension plans

¹ https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs
² https://smartasset.com/retirement/401k-55-rule

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