By Joseph Di Salvo, ChFC, and Marie Madarasz, AIF
We had a client come in recently with an old 401(k) plan notification in hand. This plan was left at a company he had terminated employment from back in 2001 and has had no contact with since. In the ensuing years, life was busy! New employment, started a family, moved homes, etc. All the good things in a young and growing household. No surprise that an old 401(k) was forgotten about. It was left at the former employer due to confusion around what should he do with it and a bit of inertia. It was fully forgotten about as the decades flew by. The value of the retirement plan continued to increase as the original investments grew and compounded. Where originally it was a small, somewhat forgettable amount, it now represented over forty thousand dollars!
The notification our client received out of the blue was a change of service notice. To determine how best to advise our client, we got on the phone with the plan’s new custodian, who quickly tried to verify our client. They had little to no information in their files with which to verify him. They could send a code to the email they had on file. Oops, that old company email address no longer existed! Could he give them the exact date he started with the employer, back in 1996? No, the date our client had didn’t match. It quickly became a quagmire! They could not verify enough information to speak with us, and we could not get the details we needed to help our client make and implement the following decision: should he roll over, stay put or withdraw this plan? (And by rollover, we mean a direct rollover, with the check made payable to the IRA custodian, not the participant.)
This is a true story and while I am confident we will resolve this for our client, it is a tale of what happens when funds are left unattended in company plans. Along with the many hoops, you may have to jump through to receive information, there may be additional requirements to complete a rollover or withdrawal, such as needing a former employers’ signature. Some rules may seem arbitrary and frustrating to a former employee. As Ed Slott says, “The rule of the plan is the rule of the land.”
When you leave your employment, what should you do with the retirement plan left behind? Well, the best advice we can give is: It depends on your unique circumstances.
Leave Assets in the Company Plan
Generally, plan assets will receive federal protection under ERISA for general creditors, state law protects IRAs. If your state offers limited or no creditor protection, and you have personal concerns around malpractice, divorce, or creditor problems or other types of lawsuits, creditor protection should be considered. IRAs will receive federal protection in bankruptcy situations only up to a current cap of $1,362,800, not for other types of judgments.
If there is a divorce, QDROs (Qualified Domestic Relations Orders) are available only from company plans, not from IRAs. Distributions from plans divided by a QDRO are penalty-free for early withdrawals. However, that benefit is lost if those funds are rolled over to an IRA.
If you are a non-spouse beneficiary, inherited IRAs cannot be converted to an inherited Roth IRAs, but inherited company plan assets can be converted to an inherited Roth IRA for a designated beneficiary.
If you are of age, you may be able to delay plan RMDs (required minimum distributions) with the “still working” exception if IRA funds are rolled over into your new company plan, with a few exceptions.
If immediate or near-term access is needed to your funds, the age 55 plan exception to the 10% penalty should be kept in mind. If you are at least 55 years old when you leave your job but not yet 59 ½ and you need access to your funds, leave the money in your plan and take your withdrawals from there. The distribution will be subject to tax, but no 10% penalty. If it is rolled into an IRA, withdrawals before age 59 ½ will be subject to the 10% early distribution penalty.
For state and local public safety employees, funds can be withdrawn penalty-free if the separation from service was in the year the employee turned age 50 or older.
And, for participants in 457(b) plans, they are exempt from the 10% early withdrawal penalty but once the funds are rolled over into an IRA, this 457(b) plan penalty exception is lost.
Rollover the plan to an IRA
First and foremost, an IRA rollover would allow the plan participant more flexibility to make changes without the administrative hurdles or delays that plans can impose, like in our example above!
Rollovers allow plan participants to take control of their funds. An IRA can be a highly flexible and customized investment vehicle versus being in a plan with limited choices. IRA owners can receive attention and advice from their own personal financial advisor, rather than a client services representative at a 1-800 number who may or may not be able to advise on planning options.
If you are charitably inclined and at least 70 ½ years of age, QCDs, or qualified charitable distributions, which allow the amount you give to the charity to be excluded from adjusted gross income even if you claim the standard deduction, can only be done from an IRA, not from a company plan.
Rollovers to an IRA allow more ease for creating the stretch IRA for eligible designated beneficiaries after the SECURE Act as well as greater flexibility in dealing with the new 10-year rule for non-eligible designated beneficiaries. It is still unknown how plan sponsors will handle these very new issues. There is a possibility that plans will not want to get involved in the administrative nightmare of keeping track of the beneficiaries of deceased ex-employees as they take required distributions. Instead, plans may simply pay out to the beneficiary in one year or at best, five years.
If you have highly appreciated company stock, consider distributing the stock in-kind to a taxable account and rolling the remainder of the plan assets to an IRA to utilize the more favorable tax treatment of net unrealized appreciation (NUA). If done correctly, the only tax owed would be on the cost of the stock when it was acquired by the plan and the participant will have access to more favorable capital gains tax treatment when the stock is eventually sold. There are strict rules around this that must be followed – make sure you seek qualified advice!
The IRA is a great place to consolidate and control the various risks (market risk, withdrawal risk, tax risk, inflation and longevity risk) that come with a portfolio that will now be or will eventually be in distribution mode. Managing and coordinating these risks effectively will best position the IRA owner to maximize their income, improve their investment results and minimize the amount they pay in tax.
You will have greater flexibility and control when the funds are in an IRA to implement a partial Roth conversion strategy.
When required minimum distributions come due, IRAs are aggregated for calculating RMDs. An IRA owner can take his/her RMD from anyone or a combination of his/her own IRAs. With company plans, the employee generally has to take their RMD from each plan separately, with 403(b)s being the exception as RMDs can be taken from any one of a person’s 403(b) plans.
Former employees have options around what to do with their plan funds when they leave a company. Consideration should be given to: When will you need access to the funds? What is the control and flexibility you will require over your assets? And, will creditor protection be necessary? Make sure you seek qualified advice to ensure you are choosing the best option for your unique situation.
About the authors: S. Joseph DiSalvo, ChFC and Marie L. Madarasz, AIF
S. Joseph DiSalvo, ChFC and Marie L. Madarasz, AIF, authors of Income for Life, a Retiree's Guide to Creating Income from Savings, specialize in coordinating a retiree’s income, investment, and tax planning. They are members of Ed Slott’s Elite IRA Advisor Group, a prestigious study group that enhances their knowledge of IRA distribution planning. Both are strong advocates of financial education, seeking to teach others how to achieve sustained success and lifelong prosperity. www.IncomeForLifeBook.com
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