Enrolling in a 401(k) has never been easier, now that about two-thirds of large employers automatically sign up new employees in their workplace retirement plans. And thanks to the growth of set-it-and-forget-it target-date funds, investing the contributions to your 401(k) is a lot easier, too.

But if you leave your job or retire, you’ll need to make some important decisions about the future of your 401(k) plan. You’ll also get a lot of advice about how to invest the money, particularly from financial institutions that offer rollover IRAs

Rolling over your 401(k) to an IRA could provide you with more investment options than your former employer’s 401(k) plan had. It could also give you more control of your account, particularly once you retire. If you’ve worked for several different employers, rolling over your orphan 401(k) plans into an IRA also provides a way to consolidate your savings.

But your retirement security could be jeopardized if you roll over your funds into an IRA that charges high fees for subpar investments. And most workers don’t realize that IRA providers are not subject to the same investor protections that cover their 401(k) plans—a situation the Biden administration wants to change.

In late 2023, the U.S. Department of Labor proposed extending the fiduciary standard, which requires providers to act in their clients’ best interest, to financial advisers, brokers and insurance agents that offer rollover IRAs. Under the 1974 Employee Retirement Income Security Act (ERISA), employers that manage 401(k) plans must adhere to the fiduciary standard, but that protection doesn’t extend to recommendations for 401(k) rollovers. This one-time advice “is often the most important advice the retirement investor will ever receive and affects roughly 5 million savers per year who are rolling their money out of 401(k)s and into IRAs,” the Biden administration said in a statement. Biden has likened the costs imposed by some IRA providers to the “junk fees” charged by resorts, concertticket sellers and others, which the administration has also targeted.

Advisers who already comply with the fiduciary standard applaud the proposal. The National Association of Personal Financial Advisors, which represents fee-only advisers— those who receive no commissions for recommending products or services—call it “a major step forward to update and strengthen the fiduciary standard of care for the millions of hard-working Americans with retirement plans.” Opponents of the measure say the rule change would make it more difficult for low- and moderate-income savers to get financial advice. Critics of the proposal also note that previous efforts to extend the fiduciary standard have been struck down in court.

What to do now.

Even if this proposal survives a court challenge, it would likely be months before it takes effect. In the meantime, there are steps you can take to protect your savings:

Let your 401(k) funds sit with your former employer.

If your former employer’s plan offers strong investment options and reasonable fees, you may opt to keep your money there. If you have a balance of at least $7,000 in your former employer’s 401(k) plan, the employer is required to allow you to leave it where it is.

Leaving your funds with your former employer is also a good idea if you’re planning to retire early. In general, you must pay a 10% earlywithdrawal penalty if you take money out of your IRA or 401(k) before you’re 59½. There is, however, an important exception for 401(k) plans: Workers who leave their jobs in the calendar year they turn 55 or later can take penalty-free withdrawals from that employer’s 401(k) plan. But if you roll that money into an IRA, you’ll have to wait until you’re 59½ to avoid the penalty unless you qualify for one of a handful of exceptions. Keep in mind that you’ll still have to pay taxes on the withdrawals.

Roll the funds into your new employer’s 401(k) plan.

This strategy may make sense if your new employer’s plan offers low fees and attractive investment options. You may also want to keep your savings in a 401(k) plan if you intend to work past age 73. Ordinarily, you must take required minimum distributions from your IRAs and 401(k) plans starting in the year you turn 73 (the age when RMDs begin will increase to 75 in 2033). But if you’re still working at age 73, most plans will allow you to postpone RMDs until April 1 of the year after you stop working. If your plan allows you to roll over money from a former employer’s plan, you can protect those assets from RMDs until you stop working.

Transfer the funds to an IRA with low fees and good investment choices.

If you’ve changed jobs several times, you may have multiple orphaned 401(k) plans holding a smorgasbord of investments that may not suit your age and tolerance for risk. In that case, it can make sense to consolidate all of your old 401(k) plans in an IRA. And once you retire, having your assets in an IRA could give you more flexibility when it comes to taking withdrawals. Although many large 401(k) plans allow retired participants to take regularly scheduled withdrawals, some are less flexible. While many 401(k) plans offer institutional-class funds that charge lower fees than their retail counterparts, you’re limited to the plan’s options, says Christie Whitney, director of financial planning for Rebalance IRA, which provides fiduciary-standard financial advice to individuals who want to roll over their 401(k) plans.

While 401(k) plans have improved in the past 10 to 15 years in terms of portfolio diversification and costs, “you’re still beholden to whatever your company’s plan is offering,” Whitney says. “With a rollover, you’re open to the whole world of investment options.”

The term equity compensation is a fancy way of saying that an employee receives some form of ownership (also known as equity) in their company as a part of their payment and benefits (i.e., the compensation package). Typically, this will be just one component of how an employer compensates an employee for his or her work — it can be included on top of salary, healthcare benefits, 401(k) match, and other perks.

If you receive any sort of stock or stock options from your employer, then you should make sure to understand precisely how this benefit works and how it fits into your unique financial situation. Some types of equity compensation may include, but are not limited to, the following:

• Restricted Stock Units (RSUs)
• Restricted Stock Awards (RSAs)
• Employee Stock Purchase Plans (ESPPs)
• Incentive Stock Options (ISOs)
• Non-Qualified Stock Options (NQSOs or NSOs)

employee stock options

Receiving stock (or options to buy stock — more on that later) in your company can be much more complicated than receiving a paycheck. For starters, you cannot take your company stock and buy groceries with it. You would have to sell it first. With this prospect, a number of questions arise:

Is it even possible to sell my company’s stock? Should I sell it? If so, how much and when should it be sold?

Do the taxes work the same as with other stocks in my investment accounts?

As with so many questions in financial planning, the answer to these questions usually is: it depends.

One major factor is whether someone works for a company that is owned privately (not actively traded on the open market) or publicly (i.e., traded on a major stock exchange — think Apple, Google, etc.). Private companies often have very limited opportunities, if any, for employees to sell their shares, especially in the near-term. Public companies allow greater flexibility for employees, but there still may be resale restrictions depending on the type of equity one receives, vesting requirements, your position in the company, and other restrictions outlined in the plan document and grant agreements.

Assuming that someone is fully vested in their employer stock and has a market to sell the shares, they should consider if or how much to sell. The risk of not selling any shares is possibly accumulating an investment portfolio where funds are highly concentrated in one company. While an employee-owner may have a strong outlook for the company, this concentration poses a risk nonetheless. In the worst-case-scenario, an individual’s company goes out of business. It that situation the employee-owner not only would lose their job, but they would also lose their investment savings (those savings in company stock) that were meant to go toward funding retirement, traveling the world, paying for a child’s college expenses, or buying a new home.

Being proactive and making a plan for your company stock will allow you to take advantage of your company’s equity compensation plan while reducing the risk of having too much of your savings in one company.

Planning ahead will also help a you know what to expect on taxes and potentially reduce your overall tax bill.

incentive stock options and non-qualified stock options

Did you know that there is different tax treatment depending on whether you exercise Incentive Stock Options (ISOs) versus Non-Qualified Stock Options (NQSOs or NSOs)?

Further, if one exercises ISOs and later sells the stock, there can be different tax consequences depending on the timeline of when the stock options were granted, when the options were exercised, and when the shares were sold. Importantly, if one exercises ISOs, they may owe income tax even if they do not sell the stock and did not receive any cash inflows! This income recognition is incurred under the rules of the Alternative Minimum Tax (AMT) system.

For example, one individual we worked with exercised enough ISOs to increase his company stock ownership by several hundred thousand dollars on top of the $1 million or more that he already held. This was a publicly traded company and the ISOs were exercised in the beginning of the calendar year when the stock price was very high relative to the exercise price of the options (i.e., what the ISO holder pays to acquire actual shares of the company). This large spread (between the stock price at exercise and the exercise price itself) would be subject to taxation under the Alternative Minimum Tax if the shares were held through the end of the year. We helped this client understand the different tax treatment of two courses of action:

• holding the shares long enough to meet the holding period requirement for capital gains tax treatment — this would have incurred a higher tax bill on the AMT component but also gets favorable tax treatment (capital gains) on the gain at sale later on; or
• selling the shares during the same calendar year in which they were exercised — this is a “disqualifying disposition” which means you are subject to ordinary income tax on the gain at sale but it also reduces the AMT component if (and this is a very important “if”) the stock price has decreased since the options were exercised.

The tax bills resulting from the two paths above can have a difference amounting to tens of thousands of dollars or more. Further, there is the subject of liquidity to consider in each of the two paths. Course A (holding the shares longer) led to incurring a tax liability before the shares were sold, meaning this individual needed to have enough cash on hand to pay the tax bill. Course B involved selling the shares, meaning some of those proceeds could be used to pay the tax bill as needed.

growing your wealth

In addition to assessing the timing and tax implications of selling stock from ISOs, we helped this client determine an appropriate investment allocation for long-term growth. Using the proceeds from the sale of company stock, he was able to invest in a diversified portfolio which significantly reduced the risk in his investment savings.

Equity compensation is an exceptional way for companies to attract top talent and for employees to be even more invested (pardon the pun) in their work. The point is not to convince people to hastily sell all of their company stock, but rather to encourage them to take a close look at how their company stock fits into the big picture of their financial and personal life. I encourage people to be proactive and understand the tax implications of selling company stock, determine how much company stock they should hold (i.e., when to start selling), and manage the risk in their investments to improve the chances of reaching their goals.

Learn more about Matt Jude and his background in Equity Compensation.