Allworth Advice: What to know if you're leaving a job

Kris from Butler County: I took out a 401(k) loan earlier this year to help with some expenses (about $6,000) and I still owe money. Now I’m thinking of changing jobs. What happens to that loan if I do switch jobs?

Answer: This is one of those cases when you need to double-check the details of your 401(k) plan and the criteria surrounding loans and loan repayment. According to a recent Vanguard study, about one out of three plans lets former workers continue to make loan payments in accordance with the plan’s repayment rules. If your plan falls into this category, then it’s a pretty simple solution – just keep making payments as you’re doing.

Things get a bit more complicated if your plan doesn’t allow for this kind of flexibility. In some cases, your plan may have a specific repayment policy that you must follow if you quit your job. And this deadline to pay the piper could come quickly – some plan policies dictate outstanding balances must be repaid immediately upon departure.

If you don’t (or can’t) repay by this deadline, the remaining balance essentially becomes a 401(k) distribution which could be taxable and, depending on your age, potentially subject to a 10 percent early withdrawal penalty. You then have until Tax Day of the following year to repay the amount. In your case, if you leave your job this year, you would have until April 15, 2022, to repay (or October 15, 2022, if you typically file an extension).

Here’s The Allworth Advice: It’s crucial to understand all the workings of your plan’s rules before you leave your current employer. The guidance of a fiduciary financial advisor – or tax professional – can be a valuable asset during this time.

G.S. in Indian Hill: I want to save in a Roth IRA, but I make more than what’s allowed. Is there any workaround?

Answer: As a reminder, a Roth IRA allows you to make after-tax contributions in exchange for tax-free growth on earnings once you’ve held the account for five years and are at least 59 ½ years old. However, as you mention, there are income eligibility limits: If your 2021 modified adjusted gross income (MAGI) is $140,000 or more as a single tax filer (or $208,000 or more if you’re married and filing jointly), you are not eligible to contribute at all.

One potential workaround is doing something called a “backdoor” Roth IRA by converting money in a traditional IRA to a Roth IRA. Doing this allows you to avoid the income limit and even the annual contribution limit. But this doesn’t mean you’re avoiding taxes. Since the money in your traditional IRA is pre-tax money (in most cases), you’ll need to pay taxes on that money when you do the conversion. Ideally, the money you use to pay that tax bill should come from an outside source – not from the money you’re converting.

The Allworth Advice is that a backdoor Roth IRA can be an option if you make too much money to contribute to a Roth IRA the “normal” way. However, we should note that this maneuver could potentially be nixed for high earners in the future depending on what legislation is proposed in Washington, D.C. So, don’t forget: If you have access to a Roth 401(k) through your employer, this type of account also gives you tax-free growth – and there are no income eligibility limits.

Responses are for informational purposes only, and individuals should consider whether any general recommendation in these responses is suitable for their particular circumstances based on investment objectives, financial situation and needs. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional adviser of his/her choosing, including a tax adviser and/or attorney. Retirement planning services offered through Allworth Financial, an SEC Registered Investment Advisor. Securities offered through AW Securities, a Registered Broker/Dealer, member FINRA/SIPC. Call 513-469-7500 or visit allworthfinancial.com.