You're about to retire, have just retired, left a company to take another job, or have been downsized. You have built up a sizable retirement account, so:
You're going to get the biggest check of your life & your lump-sum distribution. Surely this calls for some thought or pre-planning about what to do with it. And I don't mean leafing through Disneyland brochures.
Fortunately there aren't a ton of options to make your head spin. You've got three choices for what to do with your money:
- Option #1: Roll over to an IRA.
- Option #2: Stay put in the company plan (if or for as long as allowed) or roll to a new employer's plan.
- Option #3: Take a lump-sum distribution and pay the tax now.
The choice you make here is one of the critical choices which can make or break your retirement.
To gauge the tax ramifications of each option, take the following factors into consideration:
- When will you need the money?
- What will your tax bracket be in retirement?
- How is your health?
- How much money will you need for retirement?
- How much is the lump-sum distribution?
- How old are you?
- What is your estate plan?
- Who will pay the income tax?
- Will you be working again?
- Is creditor protection a big issue to you?
Each of the above questions has an important impact on the decision of moving your retirement account and is part of my client interview process. If you don't see the relevance of the question, send me an e-mail and I'll send you a further explanation of the issue that the question is getting at.
Advantages of Rolling to an IRA
1. Stretch distributions for beneficiaries.
2. Smoother estate planning.
- Heirs can keep the money growing over their live expectancies after your death.
- Heirs must take required distributions, but with proper estate and beneficiary planning, the amount remaining can continue to build up, tax deferred.
- Although a non-spouse designated beneficiary of an IRA can stretch distributions on the inherited IRA over his or her life expectancy, many plans do not allow this stretch option even though the IRA rules permit it.
3. More investment choices.
- Assets in an IRA can more easily be coordinated with your overall estate plan than assets in a company plan such as a 401(k).
- You can name anyone you wish as your beneficiary, and even split accounts, naming several primary and contingent beneficiaries.
- Funds in a company retirement plan are subject to federal law, which for the most part requires that you name your spouse as beneficiary & unless your spouse signs a waiver. An IRA rollover does not avoid the spousal waiver; it must be filed with the plan before you roll the funds, but once the funds are in your IRA, you're not required to name your spouse as beneficiary.
4. Roth conversion ability.
- You have a universe of investment choices to pick from plus the ability to customize your investment choice to meet your personal needs; this is an important consideration in economically volatile times.
- You can instantly make changes that fit your risk tolerance and retirement needs rather than going through a bureaucracy where you are now an ex-employee and thus receive little personal attention.
5. Greater flexibility, availability, and control.
- You leave the door open to becoming eligible to convert from a traditional IRA to a Roth IRA, and allow income to pass tax-free to your beneficiaries.
6. Account consolidation.
- You have no withdrawal restrictions with an IRA, whereas company plans may have some"for example, a 401(k) might not release money to you, even for a personal hardship, if you're under the minimum age requirement of 59".
- You have immediate access to your funds, regardless of your age. Of course, you'll have to pay tax and, if no exception applies, a 10 percent penalty for the early withdrawal.
- You are in complete control and don't have to ask anyone's permission to take your money out, whereas even if a company plan did allow you immediate access, if you're no longer working there because of a layoff or taking a new job elsewhere, getting your hands on that cash may take you some time. And if you need the cash right away, this will just put pressure on you at a time when the last thing you need is more stress.
- You exercise greater control over the amount of tax you pay by withdrawing more in low-income years & whereas with a lump-sum distribution, it's all or nothing; the entire account balance must be taken out, even if you don't need all that money at the time of distribution.
7. Plan portability.
- You can consolidate all your retirement plans under a single umbrella and not have to worry about keeping track of different distribution requirements and withdrawal options for each plan.
- You'll relieve yourself of so much paperwork. People are drowning with the monthly, quarterly, and annual statements they receive and the tax reporting required for each retirement account.
- You'll save countless trees!
8. Access to professional advice.
- If you aim to keep on working, you're able to roll the taxable money in your IRA account back into your new company's plan with no sweat (but you cannot roll after-tax IRA money back into a company plan). After-tax IRA money would consist of nondeductible IRA contributions and any after-tax funds rolled into an IRA from a company plan.
Advantages of Staying Put
- IRAs are handled by retirement plan professionals whereas company plans such as 401(k)s are typically handled by a clerk in the Human Resources Department.
- No more "one-size-fits-all" plan management; you get an advisor who works with you, not the company you work for, to help customize your plan decisions.
- You'll be better able to formulate a long-term retirement and estate plan for you and your family.
1. Federal creditor protection.
Advantages of the Lump-Sum Withdraw
You're protected against personal bankruptcy, malpractice, divorce, lawsuits, and any other bids on your assets from current or potential creditors on the federal level (whereas IRAs receive creditor protection on the state level).
2. Borrowing ability.
If you find yourself suddenly strapped for cash, you can get a quick loan from a qualified plan, whereas you cannot borrow from an IRA. This privilege can be an important one, but for obvious reasons should be exercised only as a last resort. If you feel that you may need to borrow in the future, you might want to roll the funds into your new company's plan and keep that option open'that is, if the new company's plan allows borrowing. Not all company plans allow that option.
3. Affordable life insurance.
Money in a qualified company plan can be used to buy life insurance, whereas IRA money cannot be used for that purpose. Why is this important? Life insurance offered through your company plan may be the only life insurance you qualify for or can afford. Leaving the plan and trying to continue the insurance on your own may prove too costly.
4. The 'still-working exception.'
You can put off the age 70 required minimum distribution (RMD) until you're fully retired. This still-working exception to the RMD rules does not apply to distributions from IRAs.
5. The 'age-55 exception.'
If you were at least 55 years old when you left your job and need to tap your retirement funds immediately, distributions from a company plan will be subject to income tax but no 10 percent early-withdrawal penalty. This exception does not apply to distributions from IRAs.
This option lets you withdraw all your pension monies in one fell swoop and get the tax bite over with. You might select this option if that balance is relatively small or if you need the balance in your retirement account right away for living expenses, medical costs, or other pressing bills. But if the balance in your plan(s) is substantial, then you'd be better off with option #1"rolling to an IRA"and withdrawing only what you need rather than being taxed on the whole enchilada.