Your retirement plan assets may be one of the most important
legacies you take with you when you move from one job to another.
Intended to help provide financial security later in life, these
assets need to be managed carefully and invested wisely in order to
help ensure that they will be available when eventually
required.
Rollover IRAs Offer a Wide Range of Benefits
When you change jobs, you have four options for your retirement
savings plan assets: keep the money in your old plan, move it to
your new plan, cash out, or transfer it to a rollover IRA. Each
option has its advantages and disadvantages. Many opt for a
rollover IRA, which can provide a broad range of investment choices
and flexibility for distribution planning. Here's a brief overview
that highlights some of the key benefits of a rollover
IRA.1
- As the IRA account owner, you make the key decisions that
affect management and administrative costs, overall level of
service, investment direction, and asset allocation. You can
develop the precise mixture of investments that best reflects your
own personal risk tolerance, investment philosophy, and financial
goals. You can create IRAs that access the investment expertise of
any available fund complex and can hire and fire your investment
managers by buying or selling their funds. You also control account
administration through your choice of IRA custodians.
- While you may look forward to a long and healthy career, life's
uncertainties may force changes. Internal Revenue Service
distribution rules for IRAs generally require IRA account holders
to wait until age 59½ to make penalty-free withdrawals, but
there are a variety of provisions to address special circumstances.
These provisions are often broader and easier to exploit than
employer plan hardship rules.
- IRA assets can generally be divided among multiple
beneficiaries in an estate plan. Beneficiaries can make use of
planning structures to extend tax deferral for 10 years or longer
following the death of the original account owner. Beneficiary
distributions from employer-sponsored plans, in contrast, are
generally taken in lump sums as cash payments. Also, except in
states with explicit community property laws, IRA account holders
have sole control over their beneficiary designations.
Efficient Rollovers Require Careful Planning
One common goal of planning for a lump-sum distribution is
averting unnecessary tax withholding. Under federal tax rules, any
lump-sum distribution that is not transferred directly from one
retirement account to another is subject to a special withholding
of 20%. This withholding will apply as long as the employer's check
is made out to you -- even if you plan to place equivalent cash in
an IRA immediately. To avert the withholding, you must first set up
your rollover IRA and then request that your employer transfer your
assets directly to the custodian of that IRA.
Keep in mind that the 20% withholding is NOT your ultimate tax
liability. If you spend the lump-sum distribution rather than
reinvest it in another tax-qualified retirement account, you'll
have to declare the full value of the lump sum as income and pay
the full tax at filing time -- at a rate of up to 37% depending on
your eventual tax bracket. In addition, the IRS generally imposes a
10% additional tax on withdrawals taken before age 59½.
As discussed above, if you plan to roll over the entire sum but
have the check made out to you rather than your new IRA custodian,
your employer will be required to withhold the 20%. In that event,
you can eventually get the 20% refunded if you complete the
rollover within 60 days. You must deposit the full amount of your
distribution into your new IRA, making up the withheld 20% out of
other resources. When you file your tax return for the year, you
can then include a request for refund of the lump-sum
withholding.
If you have after-tax contributions in your employer plan, you
may opt to withdraw them without penalty when you roll over your
assets. However, if you wish to leave those funds in your
retirement account in order to continue tax deferral, you can
include them in your rollover. When you begin regular distributions
from your IRA, a prorated portion will be deemed nontaxable to
reimburse you for the after-tax contributions.
The information contained herein is general in nature and is
not meant as tax advice. Consult a tax professional as to how this
information applies to your situation.
Special Considerations for Company Stock
Many firms make some or all of their contributions to employee
accounts in the form of company stock, bonds, or other securities.
If you have company securities in your account and their current
market value includes significant price appreciation, you may be
able to benefit from an in-kind distribution for the company
securities that is separate from the lump-sum cash-out of other
investments' assets.
An in-kind distribution is delivery of the actual securities
rather than their cash value. The potential benefit comes from the
fact that any price appreciation that occurred while the securities
were held in the 401(k) can be treated as capital gains rather than
ordinary income. When you take an in-kind distribution of your
employer's securities, you will pay income tax only on the original
cost basis of the securities; the balance of the value on the
distribution date is categorized as net unrealized appreciation
(NUA). When you sell the securities, the NUA is treated as a
long-term capital gain. Any gain that might occur after the
distribution date is taxed as if you bought the securities on the
date of the distribution. (Note that NUA treatment is available
only for publicly traded securities.)
How much could that cash distribution be worth when you
retire?
A retirement nest egg grows most vigorously when investment
proceeds are permitted to compound over long time periods. A
relatively small amount of money today may become a considerable
nest egg when earnings are compounded over a lifetime, as this
chart illustrates.
| Consider Appropriate Time
Frames2 |
 |
| Source: SS&C Technologies, Inc. For illustrative purposes
only. Example is hypothetical in nature and is not indicative of
any particular investment. Past performance is not indicative of
future returns. |
Potential Downsides of IRA Rollovers to Consider
While there are many advantages to consolidated IRA rollovers,
there are some potential drawbacks to keep in mind. Assets in an
employer-sponsored plan generally cannot be readily taken to
satisfy bankruptcy or liability judgments against you. However,
federal law protects IRA assets only in bankruptcy proceedings and
then only in designated circumstances. Liability protection is
determined by state laws, which vary. Also, you must begin taking
distributions from a traditional IRA by April 1 of the year after
you reach 722 whether or not you continue working, but
employer-sponsored plans do not require distributions if you
continue working past that age.
Remember, the laws governing retirement assets and taxation are
complex. In addition, there are many exceptions and limitations
that may apply to your situation. Therefore, you should obtain
qualified professional advice before taking any action.
