ROLLOVER DECISIONS – THE BEST AND THE WORST

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Jim Lorenzen, CFP®, AIF®

 

Bad decisions = bad consequences = big costs!

As you may have seen or heard me say many times, it’s not wise to act first and plan later; yet, that’s exactly what I’ve seen people do time and again over the last twenty-five years.  As you can imagine, I’ve seen a few mistakes.   That applies to rollover decisions, as well as other decisions regarding 401(k) and other retirement account assets.

You might enjoy seeing a short video on one big mistake many people make – and you can also get access to some additional resources and a rollover checklist I think you’ll find useful.  You can find it all here.

There’s a right way and wrong way to do a rollover, if you should do one at all.   Let’s quickly capsulize – there’s more to know, so you should consult with appropriate tax and legal advisors before acting.   Here are the six best and worst rollover decisions people make:

The Best

  1. Leave money in the qualified plan if retiring between ages 55 and 59½ and distributions are required.Since there is no penalty on withdrawals from a qualified plan after attainment of age 55 and separation from service (age 50 for qualified public safety employees), distributions are more liberal than if funds are rolled to an IRA. Once funds are rolled to an IRA, there is generally a penalty for withdrawals prior to age 59½. Therefore, it’s best for people who need money from their retirement account in this age bracket to leave the money as is, in their company retirement plan.Often, people who have already completed their rollover are younger than age 59½ and need a distribution.  In these cases, they can use rule 72(t) to avoid penalties.  When they do this, it’s best to split the IRA into pieces for maximum benefit.Each IRA stands on its own, which means that taking 72(t) distributions from one account has no effect on the others.  Therefore, if one IRA produces more income than is needed when placed on 72(t) distributions, you could split the IRA into more than one account, and use one of the smaller accounts to make your withdrawals.  I am not a CPA or an attorney; so, check with the appropriate advisors.And in the future, if you need more income, you could begin equal distributions from another account as well. This could provide greater flexibility in meeting your immediate and future income requirements if under age 59½.
  2. Make optimal use of creditor protectionSome IRA owners and financial advisors think that the recent changes to the federal bankruptcy rules automatically protect IRAs.  That is not true.  For creditor protection purposes, an individual would be wise to leave his funds in his qualified plan because ERISA gives complete creditor protection to qualified plans (note that one person qualified plans do not receive the protection—there needs to be at least one “real” employee in the plan).   If the individual does roll over his qualified plan into an IRA, it is optimal to leave these funds in a separate rollover IRA, because the protection that the funds had under ERISA will follow the funds into the rollover IRA.
  3. Re-Check Your BeneficiariesA company retirement plan (a qualified plan) is governed by the ERISA rules.  And those rules state that you must name your spouse as a beneficiary or get spousal consent to name another person.  The same rules do not apply to IRAs.Remember this all important rule—whoever you name as beneficiaries on your IRA account will inherit your IRA. Your will or living trust has no control over your IRA, so make sure your IRA beneficiaries are exactly as you desire.

The Worst

  1. Get a check from the companyOf course, this is just foolish. The company must withhold 20% from the payment, so that a person with a $100,000 account will have $20,000 withheld, and will receive a check for $80,000. In order to complete a tax-free rollover, the taxpayer must deposit that $80,000 in an IRA plus $20,000 from their pocket to complete a tax-free $100,000 rollover.The taxpayer may eventually get the $20,000 withheld as a tax refund the following year, but that will not help their cash flow, as they need to complete their IRA rollover within 60 days of receiving the check from their qualified plan.The bottom line is that people should never touch their qualified funds. The only sensible way to move funds is a direct transfer from the qualified plan to the IRA custodian and avoid withholding.
  2. Rollover company stockShares of employer stock get special tax treatment, and in many cases, it may be fine to ignore this special status and roll the shares to an IRA. This would be true when the amount of employer stock is small, or the basis of the shares is high relative to the current market value.However, if you have large amounts of shares or low basis, it might be a very costly mistake not to use the Net Unrealized Appreciation (NUA) Rules.[1]  If your company retirement account includes highly appreciated company stock, one option is to withdraw the stock, pay tax on it now, and roll the balance of the plan assets to an IRA.  This way you will pay no current tax on the Net Unrealized Appreciation (NUA), or on the amount rolled over to the IRA.  The only tax you pay now would be on the cost of the stock (the basis) when acquired by the plan.By the way, if you withdraw the stock and are under 55 years old, you have to pay a 10% penalty (the penalty is applied only to the amount that is taxable).For more information on NUA, get our complete report on the Six Best and Worst IRA Rollover Decisions.  You can do that here.
    Click here for your report!
    [1] IRS Publication 575
  3. Rollover after-tax dollarsSometimes, qualified plan accounts contain after-tax dollars.  At the time of rollover, it is preferable to remove these after-tax dollars, and not roll them to an IRA.  That way, if the account owner chooses to use the after-tax dollars, he will have total liquidity to do so.You can take out all of the after-tax contributions, tax-free, before rolling the qualified plan dollars to an IRA. You also have the option to rollover pre-tax and after-tax funds from a qualified plan to an IRA and allow all the money to continue to grow tax-deferred.The big question is, “will you need the money soon?” If so, it probably will not pay to rollover the after-tax money to an IRA, because once you roll over after-tax money to an IRA, you cannot withdraw it tax-free. The after-tax funds become part of the IRA, and any withdrawals from the IRA are subject to the “Pro Rata Rule.”

Don’t forget the video, resources and checklist, which you can access here.  And, don’t forget the report!

If you would like help, of course, we can always visit by phone.


Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

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Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-based registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Jim's picture
Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-based registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.

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