There are a few different investment options for retirement that most of you are using, such as traditional IRAs, Roth IRAs, and employer-sponsored 401(k) retirement plans.
These retirement plans allow you to squirrel away pre-tax money. When you take it out after you retire, the money is taxed at your current tax bracket rate, which will be presumably lower than your tax bracket while working (particularly if you’re in a high tax state/city and you plan on retiring to a low tax environment).
Not all your retirement savings have to be in the same place and there are certainly tax benefits to mixing your retirement accounts across a mix of pre-tax and post-tax options.
Lots of people ask what they should do with an old 401(k) when they change jobs. Some people leave the 401(k) with the previous employer while others choose to move the old 401(k) to the new employer.
But what if you only want to rollover a portion of the money? Can you do that? Let’s find out.
Is a partial 401(k) rollover possible?
Yes … under the right circumstances. The IRS has no problem with you rolling over a portion of your 401(k) into an IRA account (and leaving the rest behind in the old 401(k) plan). However, your particular 401(k) plan may not allow partial rollover as not all plans are set up for this and some will only allow you to roll over the entire lump-sum. To find out if a partial rollover is possible, contact your plan administrator.
Most people choose to roll retirement funds out of the 401(k) when they stop working for the company that sponsors it. One reason for this is to avoid collecting a bunch of different retirement accounts as you move from one job to another.
A similar question is whether you can rollover retirement funds from a current employer’s 401(k) plan (i.e. before you’ve left the company)?
The IRS allows you to roll money over whether you’ve separated from the company or not. However, not all employers permit an in-service rollover. You’ll have to check with your plan administrator or employer to find out if this is permitted at your company. The main reason for doing this (if it’s possible) is if you want to take advantage of investment options that are not available inside your current 401(k).
Reasons why you might want to do a partial 401(k) to IRA rollover
One common reason for rolling funds out of a 401(k) is to streamline your accounts into fewer ones. Each time you change jobs you have to enroll in the new employer’s plan. Once you change jobs a few times, you could have several accounts to juggle.
Another reason is to avoid paying the extra fees assessed by some 401(k) plans. Additionally, the investment choices afforded by some 401(k) plans leave something to be desired, prompting people to move money out as soon as possible.
So why would you want to do a partial rollover in the first place? Why leave part of your retirement funds in the 401(k) account?
There are a few reasons why people choose this approach.
You’re retiring between the ages of 55 and 59.5
You can take money out of a 401(k) without incurring an early withdrawal penalty once you’ve reached 55 years of age. The age limit for penalty-free withdrawals from an IRA account is 59.5.
Thus, if you retire between 55 and 59.5 you might want to roll over part of your 401(k) to your IRA to take advantage of the investment opportunities there while keeping part of the money in your 401(k) so you can withdraw it without penalty to pay for living expenses in the meantime.
Take advantage of an investment option in the 401(k)
Conversely, there may be an investment option available in your 401(k) that is not available in your IRA account. You may want to leave a portion of the funds in your 401(k) to take advantage of that opportunity. Remember, diversifying your portfolio is extremely important when it comes to investing and if you have access to something special inside your 401(k), it’s worth keeping some money there to take advantage of the investment opportunity.
Net unrealized appreciation rules
People who have appreciated employer stock in their 401(k) may also elect to roll over everything except that stock in order to take advantage of the net unrealized appreciation (NUA) rules.
What are we talking about?
The NUA of the stock is subject to different tax rules than ordinary funds and is not taxed upon distribution. You can defer the tax on the stock until you sell it and instead of paying ordinary income tax rates, you’ll follow capital gains tax rules. This can earn you a more favorable rate and save you some money.
Keep in mind that your basis in the stock is not part of this and is still subject to ordinary income tax rates. You also may face unfavorable tax implications or a 10% penalty if you pull money out before you turn 55.
Reasons why you might not want to do a partial 401(k) rollover?
Though a partial 401(k) rollover can be a good idea in certain situations, it is not without its downsides. Let’s look at some reasons why you might want to avoid this procedure.
Accidentally incurring taxes
Keep in mind that moving the tax-free money in your qualified retirement plans can incur fees if you do it incorrectly. Doing partial rollovers, particularly if you do multiple rollovers, can raise the risk of something going wrong. You don’t want to end up paying out a bunch of money due to mishandling the transfer and incurring tax consequences.
To avoid this, it’s always better to opt for a direct rollover, that is the two financial institutions handle the transfer without you ever touching the money yourself.
Keeping track of multiple retirement plans
A common reason for rolling the entirety of former employer’s plan to your IRA is to avoid having multiple accounts. From an administrative standpoint, it’s easier to manage the fewest accounts possible. Doing partial rollovers defeats this streamlining purpose if that is one of your goals.
Should you do a partial 401(k) rollover?
It really depends on your financial situation and whether or not there is an advantage to leaving part of your money invested in the current 401(k). Just know that it is possible to move a portion of your money to a rollover IRA while keeping the rest of your money in the existing 401(k) plan.
Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He knows that the Bogleheads forum is a great resource for tax questions and is always looking for honest advisors that provide good advice for a fair price.
One thing to keep in mind is if your employer or the plan provider allows for rollovers while employed. The term for that is an “in-service” rollover.
Good blog post, pretty informative. The short answers for that can be: Yes, from a tax point of view, you can roll over a portion of your 401(k) meanwhile you keeping the rest of it in one place.
A major reason for a partial rollover for retirees who are 70.5 and who make significant charitable contributions is to take advantage of “Qualified Charitable Donations” (QCDs) which are possible with an IRA but not with a 401k. Depending on the individual’s situation, there may be significant tax savings by doing so.