Enter your old employer to find your 401(k) and start your free rollover.
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By Stang Gappa
Updated on June 6, 2024
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You definitely don’t have to roll over your entire 401(k) — assuming your retirement plan provider allows partial rollovers. If they do, it means that you’re able to move only a portion of your existing balance to a new provider.
You also have the option of splitting your rollover between providers. Say you want to invest half your rollover in cryptocurrency or some other niche asset. You could roll over half the account balance to a rollover IRA at one provider that offers crypto while moving the other half to one of the more traditional online brokerages. Individuals with an employer-sponsored retirement plan can potentially roll over part of their 401(k) from a previous employer to a new employer’s plan.
A partial rollover simply means that you transfer some, but not all, of your 401(k) money to an IRA at another provider.
The key when doing any type of rollover is to ensure that the money you’re moving ends up in an account with similar tax treatment as the original account. This ensures you aren’t paying any unnecessary taxes along the way.
For example, say you have a traditional, pre-tax 401(k) at your former employer. You’ll want to ensure that you roll this into a traditional, pre-tax IRA. If, on the other hand, you have a Roth 401(k) at your former employer, any rollovers should find their way to a Roth account at another provider.
Partial rollovers can be tax-free and should be eligible for penalty-free withdrawals at age 59.5 — so long as the money is transferred between similarly tax-deferred accounts.
Note that even if you correctly perform a non-taxable rollover between two pre-tax accounts (like a traditional 401(k) and a traditional IRA), you’ll still be responsible for Required Minimum Distributions (RMDs) on all of your pre-tax accounts. Plan accordingly!
There’s a pretty good chance you won’t wake up tomorrow feeling the overwhelming urge to do a partial 401(k) rollover. But in the right situation, it could be something to think about.
Say your current 401(k) plan offers some niche investment options that you want to keep as part of your overall asset allocation. You might consider leaving that investment in your former employer’s plan and rolling over all of the other money to an IRA — one that will most likely offer a wider and cheaper investment menu.
If you have company stock in your 401(k) plan, it might not be the best idea to roll it over to an IRA. If you do choose to roll it over, you’ll pay ordinary income tax on any future withdrawals from your new account.
If this sounds like you, it might be worth transferring your appreciated company stock to a taxable brokerage account instead if you have the option. This way, upon sale of the stock, you’ll pay capital gains tax as opposed to the more costly ordinary income tax (assuming you’ve held the position for longer than a year).
Here are a few other scenarios where a partial rollover may be a viable option:
Individuals who have reached the age of 55 and have left their place of employment (or were laid off) can benefit from the IRS’s Rule of 55, which allows them to make penalty-free early withdrawals from their existing 401(k) plan without incurring the usual 10% penalty.
This essentially allows people to “bridge the gap” between retirement and the time at which they may be eligible for Social Security.
In the event that an employee’s 401(k) retirement savings plan partially consists of company stock, opting for a complete rollover to an IRA would result in ordinary income tax obligations on future withdrawals.
Alternatively, it is possible to roll over only the stock portion of the 401(k) into a regular taxable brokerage account.
If you hold the stock for at least a year before selling, you’d be liable for capital gains tax — rather than ordinary income tax — on any appreciation. “Appreciation” in this context refers to the difference between the ultimate sales price and your cost basis in the stock.
The cost basis portion of the distribution would be taxed at ordinary income rates like any other 401(k) withdrawal.
For reference, capital gains tax is generally lower (and sometimes substantially lower) than ordinary income tax.
As mentioned, individuals who hold employer stock that has experienced appreciation in their 401(k) have the option to roll over all assets to an IRA but deliberately hold back the portion of their 401(k) that represents employer stock. This strategy allows them to benefit from the net unrealized appreciation (NUA) rules.
The net unrealized appreciation (NUA) of the stock is governed by distinct tax regulations, diverging from those applicable to regular 401(k) withdrawals. When it comes to distribution to a taxable brokerage account, the NUA portion of the employer stock remains untaxed (NUA = Current Market Value of Stock – Cost Basis).
By deferring the tax on the stock appreciation until its sale, you can take advantage of capital gains tax rates instead of ordinary income tax rates. This approach offers the potential for a more advantageous tax rate.
Remember, though, that the cost basis portion of your NUA distribution will be immediately taxed at ordinary income rates. So make sure you can afford the upcoming tax bill if you try to do this!
A partial rollover is not a taxable event so long as the money is rolled to an account with like-tax treatment. This essentially means that a pre-tax retirement account must be rolled into another pre-tax account — and a post-tax account must be rolled into a post-tax one — to avoid taxation.
For example, if you roll your former employer’s 401(k) into a pre-tax, traditional IRA, you’ll be in the clear when it comes to taxes. You won’t be liable for a single penny.
However, in the most typical example of a taxable rollover, say you moved money from your pre-tax employer plan to a Roth IRA. This would trigger tax at your highest rate — your ordinary income rate — so be careful before you do this!
Speak to a qualified tax advisor or your plan administrator for more information.
If you perform partial rollovers from a 401(k), you’ll receive a Form 1099-R from your former employer at the conclusion of the tax year. Box 1 on the 1099-R reflects the distributed amount, while Box 4 indicates any federal income tax withholding.
Your Form 1099-R will also state any amount believed to be taxable, and you’ll need to report this on the face of your tax return.
If a partial 401(k) rollover is made to a Roth IRA, it can be tax-free, provided that the 401(k) account is also a post-tax Roth type. However, if the 401(k) is not a Roth type, the distributed amount will be subject to taxation as regular income, which can be especially costly.
Some of the main advantages of partial rollovers include:
The main disadvantages are:
A direct rollover, or trustee-to-trustee transfer, can be done automatically from a 401(k) to another retirement plan at a different financial institution.
Your account balance is directly transferred by the plan trustee to a new retirement plan. In the case of a trustee transfer or trustee-to-trustee transfer, there is no requirement for tax withholding because the event should be non-taxable in nature.
It’s important to note that the processing of the rollover request by the original 401(k) plan trustee may take some time.
When an individual manually withdraws funds from their 401(k) and subsequently deposits the money into an IRA account, it is referred to as an indirect rollover or a 60-day rollover. It is crucial to note that the entire amount withdrawn must be redeposited into the IRA within a 60-day timeframe to avoid a 10% early-distribution penalty.
In the case of indirect partial rollovers, the financial institution distributing the funds is required to withhold 20% of the rollover amount for tax purposes. However, despite the withholding, it’s still necessary to redeposit 100% of the funds withdrawn within the 60-day window.
This means the individual must cover the withheld 20% amount from their own pocket. Failure to do this could result in income tax consequences, early withdrawal penalties, or both — on the entire amount withdrawn.
If retirement funds are moved to and from accounts with the same tax treatment, you’ve completed a non-taxable rollover.
As long as funds are transferred between accounts with the same tax treatment, the IRS does not impose taxes on partial rollovers.
For instance, transferring money from a pre-tax account to another pre-tax account (such as from a 401(k) to a traditional IRA) or from a post-tax account to another post-tax account (like a Roth IRA to another Roth IRA) does not cause taxation.
However, it is important to avoid mixing different types of accounts, as doing so may trigger tax liabilities.
The three primary characteristics of an ideal partial rollover are:
With Capitalize, you have a trusted partner who can manage the complexities of a 401(k) to IRA rollover entirely for you, so that you can rest assured knowing the process is handled by a professional. Best of all, the service is free. Check out how we can help you here.
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