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Retirement plan rollovers are reshaping the business of financial advice.
In 2008 alone, $536 billion is expected to roll out of 401(k) plans into individual retirement accounts, according to Boston-based Cerulli Associates Inc.
Since moving money from a defined benefit or a defined contribution plan into an IRA is one of the biggest decisions an investor will make, advisers should consider all options. What's best? Let's start with the advantages of rolling over the funds into an IRA:
More early-retirement options. Clients needing money from their 401(k) plan face a 10% penalty if they withdraw funds before they are 591/2.
If funds are rolled over into an IRA, they may be withdrawn penalty-free through a strategy known as the "substantially equal periodic payments rule," in which the owner withdraws a specific sum each year using an IRS-approved calculation method.
Payments must continue for the longer of five years or until the owner reaches 591/2.
More options for beneficiaries. Many employers force non-spouse beneficiaries to withdraw plan balances over a very short time period following the death of a participant. This can produce severe tax consequences, as these beneficiaries are not allowed to roll over the assets into an IRA. When IRAs are titled and transferred properly, beneficiaries can arrange to stretch out payments over their lifetime, simultaneously stretching the recognition of income taxes.
More penalty-free withdrawal options. An IRA allows penalty-free withdrawals for higher-education expenses and first-time homebuying, which 401(k) plans and other employer retirement plans don't.
More investment options. While 401(k) plans can offer a broad range of investment options, these choices generally are limited to one account. By contrast, a client can establish multiple IRAs and name different beneficiaries on each account. Clients also may set up IRAs that have different investment objectives and can take withdrawals from any of the accounts. When clients are 701/2, the age at which required minimum distributions must commence, they can calculate RMDs for each of the IRAs separately, and the total amount could come from any one of the IRAs or be prorated among all or a select choice of IRAs.
More flexibility in paying fees. Generally, employers pay 401(k) plan administrative fees, but if client assets are invested in various funds, fees generally come out at the fund level. These can range from 0.75% to 2% and largely are buried. Asset management fees levied by IRA custodians and trustees must be disclosed when the account is opened or when the fee schedule changes. If your client pays an asset management fee, he or she will have the option to pay fees via a check or using funds from a non-retirement account.
Conversely, fees can be deducted from the IRA. Taking a fee out of the IRA to pay an asset management fee is neither a distribution nor a taxable event. Fees paid outside of the IRA can be considered for itemized-tax-deduction purposes.
Sometimes keeping retirement funds in a qualified employer plan makes more sense than a rollover. Here are some strategies that work only when money is left in a 401(k) plan:
Reducing capital gains. If company stock held in a 401(k) plan has risen significantly in value, there is a tax provision that can sharply reduce taxes on such profits.
If the stock is moved out of the 401(k) plan and into a non-retirement brokerage account, the tax bill will be based on the price of the stock when it was purchased for the account rather than its current market value.
While your client will owe income taxes and perhaps an early-withdrawal penalty, the total tax bite may be lower than alternatives. If the stock is rolled into an IRA or a new employer plan, this opportunity is lost.
Early retirement. A provision in the tax code allows plan participants to withdraw money for early retirement without paying a penalty if the participant leaves the company after he or she is 55 and withdraws the money directly from the plan.
This rule does not apply to withdrawals from IRAs.
Since any movement from a retirement plan to an IRA can result in irrevocable tax penalties, consult with a competent tax adviser before your client makes any decision. Rollovers may be the biggest financial choice your clients make, so help them choose wisely.
Dan McNamara is a Boston-based planning and investment products executive for the Global Wealth and Investment Management division of Bank of America Corp. in Charlotte, N.C. Mark Benson, also based in Boston, is president of Banc of America Investment Services Inc.
For other IN Retirement columns visit InvestmentNews Retirement Center
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