It’s Time to Move Assets Out of Your Company Plan.
What are Your IRA Distribution Options?
There has been a lot of talk, and some new regulations, regarding advice given to plan participants when they have the opportunity to move funds out of their employer plan. Here’s an example to illustrate the IRA distribution options available.
Ron has retired from his job. He has participated in his 401(k) plan at work for a number of years and has a substantial balance in the plan. What are Ron’s options for that money?
There are six options that are allowed by the tax code. An employer plan can limit these options. A plan participant will only be able to use the options available to him in his plan. All of them have pros and cons and careful evaluation of a plan participants finances and goals is necessary in order to determine the best option for that individual.
For a while, Ron could hardly watch anything on television without seeing at least one commercial from a large financial firm advertising their ability to help him do a rollover of his retirement assets. But is a rollover the best option for Ron? IRAs have some advantages over employer plans, but the reverse is also true.
Conversion to a Roth IRA
Ron could also convert all or a part of his employer plan to a Roth IRA. He would owe income tax on all pre-tax funds converted to a Roth IRA. If it turns out that Ron changes his mind for any reason about the Roth conversion then Ron can “undo” it by doing a Roth recharacterization. Ron has until October 15 of the year after the conversion to undo it.
Leave it in the Plan
Ron could do nothing and leave his money in his employer plan. In fact, that is what many ex-employees do. As with most decisions we have to make, there are pros and cons to this strategy for Ron.
Move it to a New Employer Plan
Many employer plans will allow new employees to move employer plan assets held at a former employer into their plan. This would simplify things for the plan participant. He now only has to monitor one plan instead of two or more plans.
Do an In-Plan Roth Conversion
While this option is similar to a Roth IRA conversion and much of the analysis is the same, there are some differences. Everyone with retirement assets can do a Roth IRA conversion. Not everyone can do an in-plan Roth conversion. The plan must have a Roth option, and the plan must allow for in-plan conversions. The other big difference is that Roth IRA conversions can be recharacterized. In-plan Roth conversions are irrevocable transactions. There is no undo. You are stuck with the tax on the conversion, no matter what happens.
Take the Money and Run
A lot of plan participants utilize this strategy. But they are mostly younger employees with smaller balances. Ron is not likely to take this approach… or should he? If Ron has stock of the employer for which he works in his 401(k) plan, and it is highly appreciated, perhaps he should take the money and run. He would be utilizing the net unrealized appreciation (NUA) tax strategy, which would have him pay income tax on the cost basis of his shares and pay capital gains tax on the growth on those shares when he later sells them. This can be an effective strategy for many plan participants, so it is an option that should be explored before doing a rollover. After you roll over the shares of company stock, you can no longer use this strategy.
Some Reasons to do a Rollover to an IRA or Roth IRA:
- The plan participant doesn’t need the money now.
- The ability to create a stretch IRA for beneficiaries (key point: all non-spouse employer plan beneficiaries can do a direct transfer to an inherited IRA or inherited Roth IRA)
- Wider choice of investment options
- Ability to invest in an annuity
- No withdrawal restrictions (after age 59 ½)
- No taxes due on a trustee-to-trustee (direct) transfer, a 60-day rollover from a plan will be subject to 20% withholding (taxes will be due on conversion to a Roth IRA)
- Ability to consolidate retirement accounts
- Aggregate required minimum distributions
By Beverly DeVeny, Chief IRA Analyst
Ed Slott and Company