Understanding severance packages (Part 2 of 5)

Part 2: 401(k)

Whether you’ve been at your place of employment for one year, one decade or your entire career, being dismissed from your job is never easy.

Aside from the emotional aspects of upending your daily routine and leaving colleagues you’ve become close to, your sense of identity may also take a jolt as people are often defined  – rightly or otherwise – by what they do for a living.

As you weigh your options for next steps, such as finding another job in your field, trying a new career path, starting your own business, or retirement, there are important financial considerations related to being let go.

In our five-part series on severance-related issues, we’ll explore several key areas pertaining to your finances that you should know about, in case you find yourself in this challenging position.

In this article, we discuss the potential impact on your 401(k).

Before you leave

A 401(k) plan builds wealth tax efficiently 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 this separation date. It’s a great retirement savings opportunity that will soon be lost, so take advantage while you can, as long as it makes sense for your financial circumstances. If a paycheck adjustment is needed before year-end that will reduce your take-home pay, remember 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’ll remain invested in whatever investments you’ve chosen 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 72, when the IRS currently requires that distributions begin.

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 for 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. 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 to 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. Consider rolling over pre-tax dollars to a traditional IRA, with the check made payable to the IRA custodian. Any Roth 401(k) dollars should 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 utilize, whereas funding a Roth IRA in the past wasn’t possible given 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 corporate executives and professionals make decisions about their severance and navigate this complicated, often overwhelming 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 CI Private Wealth advisor today.

Other topics in this series

• Severance and deferred compensation
• Stock awards and your investment portfolio
• Insurance
• Pension plans

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