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Mastering the rollover process for retirement plans

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By now, many advisers are well on their way to incorporating the Department of Labor’s new fiduciary rule into their investing recommendations.

But there is one more area they should be considering: the rollover process for retirement plans.

Advisers should be prepared to discuss both the benefits and drawbacks of rollovers from a company retirement plan into an IRA with clients.

In some ways, the issue doesn’t seem terribly complicated. After all, there are only three possible decisions: go with a rollover to an IRA, stay with a company plan or take a lump-sum distribution.

Unfortunately, there is no one-size-fits-all template that can be used to determine which option is best for a client. Each client’s retirement plan must be evaluated individually, based on its own merit and the specific situation.

There are numerous variables to consider. These include fees, available investments, services provided, the 10% early distribution penalty, creditor protection, convenience, required minimum distributions and estate planning.

Here are how some of these considerations come into play in leading to a particular final recommendation.


The first consideration is the status of the client.

The ability to roll over isn’t limited to participants in the company plan. Their beneficiaries have the option to roll over funds as well.

A spouse who is a beneficiary can roll over inherited company plan funds to their own traditional or Roth individual retirement account. Non-spouse beneficiaries can directly roll over inherited plan assets to an inherited IRA or directly convert the inherited plan to an inherited Roth IRA.

Deciding whether a traditional IRA with continued tax deferral or a Roth IRA with future tax-free gains is a better fit can be a tough call. Does it make sense to pay taxes on the company plan funds now in exchange for tax-free distributions from the Roth IRA later?

Probably the strongest argument for an IRA rollover is the ability of a beneficiary to stretch the money for years, keeping it growing in either a tax-deferred traditional IRA or tax-free in a Roth IRA. A non-spouse beneficiary can stretch distributions on an inherited IRA over his or her life expectancy.

But many company plans don’t allow the stretch option, even though the law does.

Company plans often don’t want to take on the headache of paying out RMDs over decades to beneficiaries of deceased ex-employees. These plans simply pay out to the beneficiary in one year or five years at best.

Another advantage to a rollover is that IRAs are more flexible than company plans in terms of estate planning and investment choices.

IRAs offer the option of splitting accounts and naming several primary and contingent beneficiaries. Clients can name anyone they wish as their IRA beneficiary.

In many company plans, a participant must name his or her spouse as beneficiary unless the spouse signs a waiver. Also, company plans may not recognize a trust beneficiary or allow disclaimers.

In an IRA, clients can customize investment choices. In addition, investment changes can be made faster in an IRA because there is usually not as much bureaucracy as in a company plan.

Another attraction of a rollover is that it is much easier to access funds in an IRA than in company plans. A client may pay tax and the 10% penalty on an IRA distribution but would still have the ability to withdraw quickly.

The company plan may have restrictions on withdrawals before 59 1/2. If clients are no longer working for the company and leave the money in the company plan, it still may take some time to access their cash.

Another potential appeal is that an IRA can be a convenient place for a client to consolidate all retirement funds. If that is done, there is no need to keep track of several different retirement plans.

IRAs can be aggregated for calculating RMDs. The employee usually has to take his or her RMD from each company plan separately.

For some clients, keeping the funds in the company plan or moving the funds to a new employer’s company plan will make the most sense. What factors weigh in favor of sticking with a company plan?

If a client is interested in delaying RMDs as long as possible, continuing with the company plan may be a good idea because of the still-working exception that may apply.

If a client is still working for the company where the plan is and that client doesn’t own more than 5% of the company, he or she may be able to delay the required beginning date until April 1 of the year after retirement. This rule doesn’t apply to IRAs.

At the other end of the time spectrum, clients who may need their retirement funds early should also give serious consideration to sticking with the company plan.

If a client is at least 55 when he or she leaves his job and needs to tap retirement funds, distributions from the company plan will be subject to tax but no 10% penalty. But if the funds are rolled to an IRA, withdrawals before 59 1/2 will be subject to the 10% early-withdrawal penalty.

The 55 exception doesn’t apply to IRA distributions.

For public-safety employees in either a defined-benefit or defined-contribution plan, the funds can be withdrawn penalty-free if the separation from service was in the year the employee turned 50 or older. This opportunity is lost if funds are rolled over to an IRA.

For some clients, creditor protection may be a concern. Company plans have an advantage here, as they receive federal creditor protection.

State laws protect IRAs, and they can vary significantly. If a state offers limited or no creditor protection, the case may be stronger for keeping the funds in a company plan instead of rolling over.

An IRA can’t be invested in life insurance, but life policies can be held in a company plan. For some clients, the life insurance offered through their company plan may be the only such coverage for which a client can qualify or pay.

Taking the money and running may sound like a bad idea at first, yet there may be very good reasons it would be in a client’s best interest not to roll over.

If a lump sum distribution from a company plan includes highly appreciated company stock or bonds, a client may roll it over to an IRA, but he or she may not want to. Under a special tax rule, the participant can withdraw the stock from the plan and pay regular income tax on it but only on the original cost to the plan and not on what the shares are worth on the date of the distribution.

The difference is called the net unrealized appreciation. A client can elect to defer the tax on the NUA until he sells the stock.

When he does sell, he or she will pay tax only at his or her long-term capital gains rate. The ability to use the NUA tax break is lost if the stock is rolled to an IRA.

This story is part of a 30-30 series on tools and strategies for retirement. It was originally published on June 2.

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