What to do with a retirement plan from an old job

[TrueVine]

When leaving a job or retiring, workers are faced with the question of what to do with their existing plans. Unless it is absolutely necessary to withdraw the funds (and subsequently pay income tax and possible penalties), it is always best to continue to defer paying the tax by either maintaining the existing the plan, transferring them into the plan of a new employer or rolling the funds over into an IRA. The impact of inflation should also not be underestimated, especially given my bias towards an expectation of severe inflation in the years to come. It would be better to pay taxes in the future with severely depreciated dollars than to pay them now with dollars worth much more. In summary, employees leaving a job face the following four options for their plan(s):

1. Take the funds as a lump sum
2. Leave the funds in the previous employer’s plan
3. Leave the funds in the previous employer’s plan for a while and then transfer them into the plan of your new employer (unless retiring)
4. Roll the funds over into an IRA

Since taking a lump sum distribution from the plan is almost always the least desirable option, I am going to dismiss option #1 and focus on the important considerations that should be made prior to selecting from options #2 through #4.

Considerations for selecting options #2 and#3: Leave the funds in the previous employer’s plan or Leave the funds in the previous employer’s plan for a while and then transfer them into the plan of your new employer (unless retiring)

• Does the plan hold valuable life insurance that cannot be transferred or replaced?
• Does the plan allow for loans (borrowing from yourself does not cost anything since you pay the interest back to yourself), which may be beneficial to you?
• Does the plan contain unique investment options that may not be available outside of it (rare)?
• Company retirement plans have federal creditor protection
• You are exempt from the 10% early-distribution penalty if you were at least age 55 when you left the company
• You can delay required distributions (for those older than 70 1/2) until you retire if you are still working and not a 5% owner of the business

Considerations for selecting option #4: Roll the funds over into an IRA

• Wide range of investment options available (e.g., individual stocks, precious metals, and annuities)
• Access to professional management of the account
• Ability to combine assets of multiple plans from former employers into one IRA account
• No withholding taxes on a trustee-to-trustee transfer
• Ability to convert directly to a Roth IRA (however, must pay income tax on the amount) or later on from a Traditional IRA if advantageous from a tax standpoint. You can just convert a portion of the entire amount. It doesn’t have to be the entire balance. Roth IRAs do not require you to take distributions at age 70 1/2.
• Estate planning with an IRA is easier than with a retirement plan

Generally, option #4 is the best for most people. If you do decide to roll the funds over into a Traditional IRA it is critical that the following steps are taken:

1. Setup the Traditional IRA with your chosen financial institution (e.g., brokerage company) if you do not already have one opened you want to use. Most financial institutions will call it a Rollover IRA or a Traditional Rollover IRA. If your options for a new IRA account include both Traditional IRA and Rollover IRA, then select Rollover IRA. A Rollover IRA is essentially the same thing as a Traditional IRA, however, they are specifically called a Rollover IRA or a Traditional Rollover IRA since they are funded with funds “rolled over” from a company plan instead of direct contributions.

2. Make sure you request a direct rollover (sometimes called a trustee-to-trustee transfer) from your previous employer’s plan to your Traditional IRA (again, usually called a Rollover IRA or Traditional Rollover IRA). In this scenario you never touch the funds and the transfer is not subject to income tax withholding. Also, since individuals are limited to one rollover a year per account and a direct rollover does not count towards this, you will not use this up in case you need to do multiple rollovers from the account. You do not want your former employer to issue you a check in your name and you do not want them to send the funds directly to you, because (1) the funds will be subject to 20% income tax withholding, (2) you will only have 60 days to transfer them, and (3) you will use up your one allowed rollover for the year. If your former employee’s benefits department says they do not do direct rollovers and only issue checks for rollovers then demand (nicely) that the check be made out instead to “(Your Financial Institution) as trustee of Individual Retirement Account of (Your Name).” This way the check can only be cashed by your financial institution and qualifies as a direct transfer under IRS regulations. If the rollover is not done as a direct rollover and a check is made out to you and sent to you then do not cash it! You need to mail the check to the financial institution where your IRA is held. The funds will be subject to 20% withholding, however, the withheld amount can also be rolled over. You have 60 days to transfer it to the IRA. If the rollover is not done in 60 days the funds are considered to be income for the year and subject to tax.

If you decided to do a rollover into a Roth IRA the rollover process is essentially the same, however, you will have to pay income tax on the funds for the year of the rollover. This may be the better option for younger individuals with small accounts, because the income tax can be paid upfront while the amount is small. The Roth IRA will then eventually be entirely tax free if the IRA is at least 5 years old when the distributions are taken. For someone who is 30 years old, they could benefit from tax free growth of the investments in their Roth IRA for decades. If they never use the funds, or only use some of the funds, their beneficiaries could also benefit from extended tax free growth over their lifetimes. If a grandchild is named as a beneficiary they could “stretch” the tax deferred growth for the rest of their lives, which could potentially be another 70-80 years! As always, this is subject to Jesus not returning first!

I highly recommend getting assistance from a competent financial adviser if you face this situation, especially if your retirement plan has a sizable amount of assets in it. They can also be especially helpful when deciding to do a rollover into a Traditional or a Roth IRA and providing professional management of the funds once they are in the IRA.

God bless,
Joshua Hall,ChFC
www.truevineinvestments.com

[ontargetcoach]

Joshua,
Good research on your article. I left my last 401K with my employer for one reason alone. I loved the funds I was in and wouldn't be able to invest in those same funds again on my own due to minimums required by that fund family. In all other cases, my wife and I have done a direct roll over to Traditional IRA. Again, good article.

[TrueVine]

Thank you!