Financial Planning During a Career Move: Think Before you Roll

Financial Planning During a Career Move: Think Before you Roll

By: Anthony Criscuolo, CFP®, EA, Senior Wealth Manager

This May I had my first, first day of work with a new company in 17 years. A career move is exciting! It’s a fresh start, a new beginning, and an opportunity for growth. It’s also an excellent time to engage in thoughtful financial planning.

Navigating a career transition is not only about embracing new professional challenges but also carefully managing the complex financial issues related to such a move. Let’s examine some of the financial planning considerations for professionals undergoing a career change, focusing on optimizing your financial outcomes and setting yourself up for long term success.

Begin with a detailed evaluation of the financial implications of your career move. It’s obvious you will consider salary variations, differences in benefits packages, and potential relocation costs. Consider the broader economic factors, such as cost of living adjustments if you are moving to a different geographic area or have higher commuting costs. Calculate the total impact on your income and expenses, including any transition periods between employment, changes in bonus structures, and the timing of compensation.

You may have a large one-time spike in taxable income in the year of your career switch, especially if you receive a sign-on bonus and/or a large vacation payout from your prior employer. This could push you into a higher tax bracket or impact other tax planning strategies you may have been pursuing. It could limit certain deductions you were accustomed to taking, or other tax credits that could be phased out at higher income levels. A detailed tax projection will help provide a clearer picture of your tax liabilities. If you are making a career move towards the end of a calendar year, you may want to consider if you can control the timing of any one-time payments to optimize your tax planning.

The influx of cash could also allow for other one-time planning considerations such as maxing out retirement accounts or Health Savings Account (HSA) contributions for the year if you don’t normally already do so. You may also want to strategically allocate surplus funds towards enhancing your investment portfolio, accelerating debt repayment, or increasing your emergency reserves. The uncertainty associated with a career move underscores the need for a more robust emergency fund. Depending on the stability of the new position and the industry’s volatility, consider expanding your emergency reserves beyond the standard six months’ worth of expenses to safeguard against unexpected disruptions.

Transitioning to a new employment situation often requires reassessing your insurance needs and coverages. Analyze disparities in health, life, and disability insurance between your former and new employer. This assessment should cover any gaps during the transition and evaluate the need for supplemental policies to ensure comprehensive coverage during and after the move. You may also want to look at increasing coverage, especially if your income is materially higher. You should also consider if you will be moving to (or from) a high deductible health plan which will impact your ability to use a Health Savings Account.

One of the most critical decisions during a career change involves what to do with your retirement plans – both new and former. If you are moving from one employer’s plan to another, you face a few choices:

1. Leaving Your Retirement Funds with Your Previous Employer: This might be advisable if the plan has superior investment options or lower fees. It may also help facilitate other planning strategies such as back-door Roth IRA contributions (more on this below).
2. Rolling Over to Your New Employer’s Retirement Plan: If the new plan offers robust investment options and lower administrative costs, this can be a convenient way to consolidate your retirement savings. However, consider whether this move aligns with your overall retirement strategy, or you may prefer a rollover IRA to have the most control and flexibility.
3. IRA Rollover: While rolling over your previous employer’s retirement plan into an IRA provides control over your investment choices, it could impact your ability to utilize back-door Roth IRA contributions due to the pro-rata rule. This rule requires that you consider all your IRAs to determine the taxable amount when converting non-deductible IRA contributions to a Roth IRA. So, if you have a large pre-tax IRA and then try to make future back-door Roth IRA contributions you will be subject to taxes.

Let’s look at a simple example of how this works in practice:

John, a 45-year-old professional, is changing jobs and considering what to do with his $500,000 401(k) from his previous employer. John also uses a back-door Roth IRA strategy each year and plans to continue this going forward. This back-door Roth IRA strategy involves making annual non-deductible contributions to a traditional IRA and then converting them to a Roth IRA (because the IRA contribution was non-deductible, the Roth conversion is not a taxable event). This is a strategy to fund a Roth IRA even if your income is too high to make a direct contribution to a Roth IRA (hence the name “back-door” Roth IRA).

Step 1: Rollover Decision

Without planning, John decides to roll over his $500,000 from the 401(k) into a new rollover IRA. He thinks this is the best option to cut all ties with his old employer and to have the most control of the investment options. He also contributes $7,000 as a non-deductible contribution to a traditional IRA for the year as the first step in his annual back-door Roth strategy.

Step 2: Converting to Roth IRA

Next, John converts only his $7,000 non-deductible contribution to a Roth IRA at the end of the year; however, the pro-rata rule is used to determine the taxable amount of the conversion.

Pro-Rata Rule Tax Calculation:

• The IRS calculates the taxable amount of the conversion based on the total balance of all IRA balances.
• Total IRA balance = $507,000
• After-tax contributions = $7,000
• Percentage of after-tax contributions = $7,000/$507,000 =1.38%
• When John converts $7,000 to a Roth IRA, only 1.38% of the amount converted ($97) is considered after-tax and thus not taxable. The remaining 98.62% ($6,903) is a taxable conversion.

If John is in the 24% tax bracket, his tax due on the conversion will be $1,657. If John had not rolled over his 401(k) into his IRA, and instead left his 401(k) in his former employer’s plan or was able to roll it over into his new company’s retirement plan, he could convert $7,000 entirely tax-free (assuming no other traditional IRA balances exist). And remember this back-door Roth IRA strategy is an annual planning opportunity, not a one-time event.

The large pre-tax balance in the IRA due to the rollover from the 401(k) results in a significant tax liability when John attempts to utilize the back-door Roth IRA strategy each year. This example illustrates the importance of carefully considering the tax implications and your overall retirement savings strategy when deciding on rollovers. This is particularly true for those planning to make back-door Roth IRA contributions, which is an excellent planning opportunity, especially for younger individuals who have a longer time horizon to take advantage of this annual planning strategy (and the tax-free growth inside the Roth IRA). Too often career movers simply do an IRA rollover reflexively without first understanding and considering the longer-term planning opportunities. Even if you have not been using the back-door Roth IRA strategy previously, your new career (and hopefully higher income) may allow you to start using this strategy going forward. So planning is not just looking backwards at what you have always done but thinking about the future and the new planning opportunities in front of you.

The overall takeaway is to use your career transition as an opportunity to review and refine your financial planning strategy – or do planning for the first time if you haven’t already. It may be a good time to reach out to an advisor for help and guidance. By undertaking a detailed analysis of the financial impacts, reconfiguring your budget, reinforcing emergency reserves, reassessing insurance needs, carefully managing retirement rollovers, and engaging in tax planning, you can navigate your career change with financial acumen and confidence. This proactive approach ensures that your career advancements contribute positively to your overall financial well-being.

If you read this to the end you probably recently changed careers or are considering a change, so let me say, congratulations – good luck and remember to do your planning!