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. But generally speaking, you’ll have the flexibility to decide how much to move and how much to leave in your employer’s 401(k).
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 rollover amount to a new IRA at one provider that offers crypto while moving the other half to one of the more traditional online brokerages.
What is a partial 401(k) rollover?
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 tax 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.
This is not to say it’s impossible to move money to accounts with different tax treatments, but you’ll need to be especially careful before you do it — more on this later.
Why would you want to do a partial rollover?
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 option that you want to keep as part of your overall asset allocation. You might consider leaving that investment in the 401(k) plan, and rolling over all of the other money to an IRA — one that will most likely offer a wider and cheaper investment menu.
One other opportunity for a partial rollover has to do with the “Rule of 55”. The Rule of 55 allows workers who were laid off, quit, or otherwise separated from employment to take penalty-free withdrawals from their 401(k) plans. This essentially allows people to “bridge the gap” between retirement and the time at which they may be eligible for Social Security.
A partial rollover, in this case, would serve two purposes: fund this “bridge period” and optimize your long-term investment. After a partial rollover, the money left in your 401(k) plan could be used to fund short-term expenses and the money rolled over to an IRA could be invested for the long term at lower cost and with greater flexibility.
Last, 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 you have the option, it might be worth transferring your appreciated company stock to a taxable brokerage account instead. 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).
Is a partial 401(k) rollover a taxable event?
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 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!
What are the advantages of a partial 401(k) rollover?
Some of the main advantages of partial rollovers include:
- IRAs tend to be much more cost-effective
- Allows you to preserve unique investments in the 401(k), if you have them
- May make sense for some people nearing retirement (see: Rule of 55)
- Tax-free if moved to an account of like-tax status
What are the disadvantages of a partial 401(k) rollover?
The main disadvantages are:
- Can increase the complexity of your retirement plan if no benefit is identified in advance
- May block or make costly a future “Backdoor IRA” contribution due to the “pro-rata” rule
- Lose maximum protection from creditors. 401(k)s are maximally protected from creditors, bankruptcy proceedings and court judgments. Traditional and Roth IRAs do not have the same level of protection.
- Can be taxable if done carelessly or improperly. As mentioned above, remember to roll money into accounts with similar tax treatment to avoid taxation.
Where should you partially rollover your 401(k) to?
The three primary characteristics of an ideal partial rollover are:
- It’s deliberate. Remember, you always have the option to leave your entire 401(k) in place or roll over the entire thing. Make sure there’s a good reason to do only a partial rollover, like the Rule of 55 or if you have some unique investment in your 401(k) that you don’t want to move. The last thing you need in a retirement plan is unnecessary complexity.
- You’re moving money to a low- or no-cost provider. If you’re moving any amount of money to any new firm, it’s always important to know exactly how much you’re paying and the exact services you receive in return. Most online IRA providers don’t charge to open an account or to invest money.
- You picked a new provider with a wide investment menu. One of the biggest criticisms of many company plans is that they offer too few investments at too great a cost. Make sure that the company you choose to hold your new IRA offers a wide range of investment options and one that won’t restrict your choices.
