Jobless? What to do with your 401k

Make a rollover to a Roth IRA

Is your adjusted gross income below $100,000 for the tax year of your Roth IRA contribution? Do you expect to be in a higher bracket at retirement? If so, rolling over your 401k to a Roth IRA may be your optimal choice -- if you can afford the tax hit.

When you roll to a Roth, you'll pay ordinary income tax on the assets converted. If you do it in 2010, that tax is spread over two years and the income cap for transfers disappears.

But it's not as easy and clear as you might think. Consider the impact of the additional income on your tax return. For example, more income may make your Social Security taxable, decrease your personal exemption and reduce your total itemized deductions. And that's after they've taken hits from the 7.5% medical expense floor and the 2% floor for miscellaneous deductions. And given the money that Congress is throwing around, I suspect marginal tax rates will be higher then as well. That might argue for doing the conversion in 2009 if you qualify.

Here's what you get with a Roth IRA:

• Tax-free appreciation.

• Tax-free withdrawals for you and your heirs.

• Freedom from minimum distributions.

• Potentially lower fees.

• Expanded investment choices, compared with a 401k.

Transfer to a new employer's 401k plan

When you find another job, you can transfer your 401k plan to your new employer with no tax consequences. Just as with your former 401k plan, you have protection from creditors, continued tax-deferred growth, the option of borrowing against the account and no 10% penalty if you wait to take distributions until age 55 or older.

You'll have to make sure the new plan permits transfers and loans. Just because it's OK under the Internal Revenue Code doesn't automatically mean your plan allows it. That's also true if your heirs want to stretch out distributions.

Review the new plan's investment options and fees as well. You're electing to make a completely new investment. Understand what you're getting into and what kinds of handcuffs you're agreeing to wear.

If you have company stock

One final word on a concept the accountants call "net unrealized appreciation." If you have employer stock in your 401k, you get a special benefit. If such stock is transferred to a taxable brokerage account, you pay only ordinary income tax on the value of the stock at the time it went into your account (your cost basis). When you sell the stock, any appreciation over that basis is taxed at long-term capital gains rates, currently capped at 15%.

So not only do you defer the tax on the appreciation until the sale, but that tax is limited to the maximum long-term capital gains rate as well. Once you roll the assets into a traditional IRA, that potential benefit is lost. All subsequent withdrawals are fully taxed as ordinary income.

Updated Nov. 24, 2009

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