By ALAN KONDO, CFP, CLU
Have you switched jobs or retired recently and are wondering what to do with your 401(k), 403(b), or 457 accounts left with your old employer? Some companies allow you to leave them where they are, but a Rollover IRA may be a better choice. A Rollover IRA can provide you with the broadest range of investment choices and the greatest flexibility for distribution planning. They can typically be operated with fewer restrictions. A Rollover IRA gives you:
– More control: When you own an IRA, 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. Your IRA can access the best investment expertise and can hire and fire investment managers by buying or selling their funds. You also control account administration through your choice of IRA custodians.
– More flexibility: IRAs can be more useful in estate planning than employer-sponsored plans. IRA assets can generally be divided among multiple beneficiaries in an estate plan. Each of those beneficiaries can make use of tax-advantaged planning structures such as the Beneficiary IRA. Transfers from the deceased owner’s IRA to a Beneficiary IRA are tax-free when done correctly, and the tax-deferred growth continues for another generation. Distributions from employer-sponsored plans, in contrast, are generally taken in lump sums as taxable cash payments.
Efficient Rollovers Require Careful Planning
One common goal of planning for a lump-sum distribution is averting unnecessary tax withholding. Unfortunately, unnecessary tax withholding is often what happens when people say, “Send me the check.” Under federal tax rules, any lump-sum distribution from an employer-sponsored plan that is made out directly to the employee is subject to a special withholding of 20%.
To avert the withholding, you must first create your Rollover IRA. Then, request that your employer transfer your 401(k), 403(b) or 457 assets directly to the custodian of that IRA. When you receive the check it should read similar to, “Pay to the order of Custodian FBO (this means for the benefit of) Your Name.”
It is easy to check off the wrong box on the employee benefits form and end up holding a check made out to you rather than your new IRA custodian. Worse, you realize that it is only 80% of the account value. Your employer was required to withhold 20% and send it to the IRS for taxes. You can eventually get the 20% refunded if you complete the IRA Rollover within 60 days. You must deposit the full amount of your distribution in your new IRA, making up the withheld 20% out of other accounts. When you file your tax return at the end of the year, you can then include a request for refund of the 20% withholding. It will take some time.
Keep in mind that the 20% withholding is not your ultimate tax liability. If you spend the lump-sum distribution rather than rolling it into an IRA or other tax-qualified retirement account, you will receive a 1099 at the end of the year and have to pay the full tax at filing time. In addition, the IRS generally imposes a 10% penalty tax on withdrawals taken before age 59½.
Potential Downsides of IRA Rollovers
While there are many advantages to consolidated IRA rollovers, there are some potential drawbacks to keep in mind. Assets greater than $1 million in an IRA may be taken to satisfy your debts in certain personal bankruptcy scenarios. Assets in an employer-sponsored plan may offer greater creditor protection in some circumstances. Also, you must begin taking distributions from an IRA by April 1 of the year after you reach 70½. Some employer-sponsored plans like 403(b)s do not require distributions if you continue working past 70½.
Remember, the laws governing retirement assets and taxation are complex. In addition, there are many exceptions and limitations that may apply to your particular situation. Therefore, you should consult with your Certified Financial Planner or CPA before taking any action.
The opinions expressed above are solely those of Kondo Wealth Advisors, LLC, a Registered Investment Advisor in the state of California. Neither Kondo Wealth Advisors, LLC nor its representatives provide legal, tax or accounting advice.