Archives for December 2013

A reader writes in, asking:

“After quitting my job, is it possible to do a rollover with just part of my 401k? I would like to be able to move some money to an IRA but keep some of it in the 401k.”

Yes, from a tax standpoint, you are allowed to roll over a portion of your 401(k) while keeping the rest of it in place.

I say “from a tax standpoint,” because there’s also the administrative standpoint to consider: Not all 401(k) plans are set up to allow partial rollovers. (Your plan administrator will be able to tell you whether your plan allows them.)

A partial rollover can be helpful if, for instance, your 401(k) has one investment option that is both excellent and not available to retail investors, but the rest of the investment options are miserable. In such cases, it can make sense to keep just enough money in the account to hold as much of that one investment as you want to hold, while rolling everything else out of the account to an IRA.

Partial rollovers can also be helpful if you retire between ages 55 and 59.5. In these cases, due to a separation from service in or after the year in which you turn age 55, you would have penalty-free access to the 401(k) money, but because you’re not yet age 59.5, you might not have penalty-free access to traditional IRA money. As a result, you may want to roll over part of the 401(k) — in order to be able to invest it however you want — while leaving enough money in the 401(k) to satisfy living expenses until you reach age 59.5.

Partial rollovers are also one way to take advantage of the “net unrealized appreciation” rules if you have appreciated employer stock in your 401(k). That is, you roll everything except the appreciated employer stock into an IRA, and, in the same year, you do an in-kind distribution of the employer stock to a taxable account, thereby allowing the appreciation to be taxed (when you sell the stock) at long-term capital gains tax rates rather than ordinary income tax rates. (Your basis in the employer stock will still be taxed at ordinary income tax rates when you take it out of the 401(k). And if you’re under age 59.5, it’s possible that the basis will be subject to the 10% penalty as well.)

A reader writes in, asking:

“It has become clear that barring a market catastrophe, our portfolio will probably outlast us. We’re nowhere near the point where estate tax would be a concern, but I’ve been thinking about how to maximize the value we leave to our children.

Rather than splitting our Roth and traditional IRAs equally between our children, what do you think about leaving our Roth IRA entirely to our child who is in a higher tax bracket and leaving most of the traditional IRA to our child who is in a lower tax bracket. We would set it up so they each receive the same net amount after taxes, and this way they both get more, after taxes, than they would if we split it equally.”

If the goal is to maximize the total after-tax value of the assets you leave to your heirs, it can make sense to:

1. Leave a greater portion of your tax-deferred assets to the heir(s) with the lowest marginal tax rate, while
2. Leaving more Roth assets and assets that would that would qualify for a step-up in basis (e.g., appreciated stocks in a taxable brokerage account) to the higher-tax-rate heir(s).

Still, there are two potential hangups.

First, there’s simply no way to ensure that each of your heirs actually receives the same after-tax amount. Most likely, your children will be taking distributions from the inherited retirement accounts over a period of multiple years, and your children’s respective marginal tax rates will surely change over the course of those years as their income changes and as legislatively-determined tax brackets change. In addition, unless all of the accounts have the same exact asset allocation, the different accounts will perform differently prior to your death, resulting in imbalances between the amounts received by each heir.

Second, if your heirs don’t understand why you split the accounts unevenly, it could cause ill will between them (or toward you) after your death. Assuming that’s a situation you’d like to prevent, it will be critical to get the kids on board with this idea ahead of time, to make sure they understand why you’re doing it (i.e., to maximize the after-tax value to be split among them) and to make sure they agree it’s a good idea, even though it means that they will not receive identical amounts.