Dealing with company buyouts – Part 2: 401(k)

PART 2: 401(k) and Supplemental 401(k)

Mergers and acquisitions are a common business strategy and often result in a realignment of talent among mid- and upper-tier executives. Many jobs are eliminated, and severance packages are offered. If your company has recently been acquired or will merge with another company, it’s often wise to take immediate action to preserve the compensation you’ve earned and create a strategy to help strengthen your financial future. 

Even if your position will likely be eliminated, there’s usually time to make key decisions. It often takes several weeks or months to develop and execute strategies for the new management structure and key jobs in the combined organization.

In our six-part series on the potential impact of a company buyout, we’ll discuss several important issues related to your finances that you should think about and potentially address. 

In this article, we explore the 401(k) and Supplemental 401(k) plans for retirement savings.

401(k) retirement savings plan

Once you learn your job is being eliminated, one of the first items we recommend you address is ensuring that you fund your 401(k) plan to the maximum before your termination date. For 401(k) deferrals made on a pre-tax basis, this tax savings will likely be valuable in your final year of employment at the company, especially given any severance payments received.

For example, let’s say your termination date is June 15, and there will be five pay periods prior to your termination date. You may need to adjust your 401(k) contribution percentage so the IRS maximum of $22,500 (in 2023) is deferred into your 401(k) plan before your termination date. If you’re age 50 or older in the year of termination, consider funding the “catch-up contribution” of $7,500 (in 2023) before termination. Even if you secure another job later in the year, at least you’ll already have taken full advantage of this pre-tax deferral opportunity.¹

Upon termination, you have options with your qualified 401(k) plan. First, you can leave your account where it is. Your balance will remain invested as you’ve directed and any growth will be on a tax-deferred basis. You can still access your account balance on the 401(k) website. Withdrawals are not required until you’re age 72, when the IRS rules apply for required minimum distributions.²

If you’re between ages 55 and 59 ½ when your employment is terminated, and you think you may need to withdraw from your 401(k) plan before you turn 60, consider leaving all or a portion of your balance in the 401(k) plan. A special rule applies to 401(k) withdrawals where you can avoid the 10% early withdrawal penalty (that generally applies to distributions from retirement accounts before age 59 ½) if you’re at least 55 in the year you separate from service. If you leave a portion of your 401(k) balance in the company’s 401(k) plan until age 59 ½, the 10% early withdrawal penalty no longer applies to any retirement account.³

Next, you have the option to roll over your 401(k) balance, tax-free, to another employer’s plan or an IRA. Upon instructing the 401(k) provider to commence a rollover of your 401(k) account to an IRA, they will liquidate your holdings and process your distribution request. However, shares of company stock can often be transferred from a 401(k) account directly into an IRA. 

The first distribution payment will likely represent your “pre-tax” balance. You’ll want this money transferred to your IRA custodian. The distribution should not be deposited into your personal bank account. If applicable, a second distribution may be made that represents any “after-tax contributions” in your 401(k). After-tax contributions are the dollars on which you already paid taxes over the years and then deposited into your 401(k) from your paycheck. Typically, our clients directly deposit this after-tax amount into their Roth IRA, but you can also receive it in cash and deposit it into your personal bank account. 

If you’ve been investing in company stock inside your 401(k) plan for a long time and have “low-cost-basis” shares, consider a tax strategy known as Net Unrealized Appreciation (NUA). In the right scenario, NUA could save thousands of dollars in income tax. With this strategy, you may transfer some or all of the company stock held in your 401(k) plan to a brokerage account at termination and then sell the shares in the brokerage account, paying long-term capital gain tax rates. 

Ordinary income taxes will be due on the cost basis of the shares distributed from the 401(k) plan, not the fair market value of those shares.⁴ Plus, if you donate shares to charity in the year of this transaction, you could greatly reduce the overall tax impact. Consult an expert before proceeding, as there are many requirements for this strategy to work properly. We recommend evaluating NUA before diversifying large amounts of company stock inside your 401(k) plan or before initiating a rollover to another retirement account. 

Finally, if you roll over your 401(k) plan to another retirement account following termination, ensure that your new beneficiary designations are properly coordinated and integrated with your overall estate plan.

Supplemental non-qualified 401(k)

Supplemental 401(k) plans differ from qualified 401(k) plans. It’s a company non-qualified plan available only to select highly paid employees.⁵ For many executives, this plan will pay out in cash shortly following termination. The value of this account is subject to ordinary income tax the year the proceeds are distributed to you, and some income tax will be withheld from this distribution. Keep in mind that it might not be enough to cover your personal tax liability on the year’s payout of this plan.

Since the payout and income tax ramifications of the 401(k) plan and Supplemental 401(k) plan are different, you may have had a different beneficiary structure for each to optimize your estate plan. Also, you could’ve been counting on the Supplemental 401(k) plan balance to fund a trust for estate planning reasons in the event of your death. Since this account is typically liquidated following termination, you may need to revisit your estate funding plan.

We’re ready to support you

To make wise decisions when facing a corporate restructuring, we believe you need to understand all the aspects of how this significant change may impact your finances now and in the future. Our team has the experience and expertise to develop your personal strategy, helping you make appropriate moves regarding your separation or transition package and, more importantly, gain clear insights into the potential impact on your overall financial well-being.

Other topics in this series:

• Severance, deferred compensation, investments
• Stock options and restricted stock
• Pension plans
• Insurance planning
• Tax and estate planning

1 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits
2 https://www.irs.gov/newsroom/irs-reminds-those-over-age-72-to-start-withdrawals-from-iras-and-retirement-plans-to-avoid-penalties
3 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions
4 https://www.investopedia.com/terms/n/netunrealizedappreciation.asp
5 https://www.investopedia.com/terms/s/serp.asp

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