Your retirement plan assets may be one of the most important
legacies you take with you when you move from one job to another.
Intended to help provide financial security later in life, these
assets need to be managed carefully and invested wisely in order to
help ensure that they will be available when eventually
Rollover IRAs Offer a Wide Range of Benefits
As compared with employer-sponsored retirement accounts, a
rollover IRA can provide you with the broadest range of investment
choices and the greatest flexibility for distribution planning.
Also, a rollover IRA can typically be operated with fewer
restrictions. Here's a brief overview that highlights some of the
key benefits of a rollover IRA compared with an employer-sponsored
- As the IRA account owner, 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. You can create IRAs that access the investment expertise of
any available fund complex, and can hire and fire your investment
managers by buying or selling their funds. You also control account
administration through your choice of IRA custodians.
- While you may look forward to a long and healthy career, life's
uncertainties may force changes. Internal Revenue Service
distribution rules for IRAs generally require IRA account holders
to wait until age 59½ to make penalty-free withdrawals, but
there are a variety of provisions to address special circumstances.
These provisions are often broader and easier to exploit than
employer plan hardship rules.
- IRAs are 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 planning structures such as the Stretch IRA concept to
maintain tax-advantaged investment management during their
lifetimes. Beneficiary distributions from employer-sponsored plans,
in contrast, are generally taken in lump sums as cash payments.
Also, except in states with explicit community property laws, IRA
account holders have sole control over their beneficiary
Efficient Rollovers Require Careful Planning
One common goal of planning for a lump-sum distribution is
averting unnecessary tax withholding. Under federal tax rules, any
lump-sum distribution that is not transferred directly from one
retirement account to another is subject to a special withholding
of 20%. This withholding will apply as long as the employer's check
is made out to you - even if you plan to place equivalent cash in
an IRA immediately. To avert the withholding, you must first set
up; your rollover IRA, and then request that your employer transfer
your assets directly to the custodian of that IRA.
Keep in mind that the 20% withholding is NOT your ultimate tax
liability. If you spend the lump-sum distribution rather than
reinvest it in another tax-qualified retirement account, you'll
have to declare the full value of the lump sum as income and pay
the full tax at filing time - at a rate of up to 35% depending on
your eventual tax bracket. In addition, the IRS generally imposes a
10% penalty tax on withdrawals taken before age 55 from an
employer-sponsored plan and age 59½ from an IRA.
Also, if you plan to roll over the entire sum, but have the check
made out to you rather than your new IRA custodian, your employer
will be required to withhold the 20%. In that event, you can get
the 20% refunded if you complete the 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 resources. When you file
your tax return for the year, you can then include a request for
refund of the lump-sum withholding.
If you have after-tax contributions in your employer plan, you may
opt to withdraw them without penalty when you roll over your
assets. However, if you wish to leave those funds in your
retirement account in order to continue tax deferral, you can
include them in your rollover. When you begin regular distributions
from your IRA, a prorated portion will be deemed nontaxable to
reimburse you for the after-tax contributions.
Special Considerations for Company Stock
Many firms make some or all of their contributions to employee
accounts in the form of company stock, bonds, or other securities.
If you have company securities in your account and their current
market value includes significant price appreciation, you could
benefit from an in-kind distribution for the company securities
that is separate from the lump-sum cash-out of other investments'
An in-kind distribution is delivery of the actual securities
rather than their cash value. The potential benefit comes from the
fact that any price appreciation which occurred while the
securities were held in the 401(k) can be treated as capital gains
rather than ordinary income. When you take an in-kind distribution
of your employer's securities, you will pay income tax only on the
original cost basis of the securities; the balance of the value on
the distribution date is categorized as net unrealized appreciation
(NUA). When you sell the securities, the NUA is treated as a
long-term capital gain. Any gain that might occur after the
distribution date is taxed as if you bought the securities on the
date of the distribution. (Note that NUA treatment is available
only for publicly traded securities.)
|How much could that cash
distribution be worth when you retire?
|A retirement nest egg grows most vigorously when investment
proceeds are permitted to compound over long time periods. A
relatively small amount of money today may become a considerable
nest egg when earnings are compounded over a lifetime, as this
|Source: Standard & Poor's. For illustrative purposes only.
Example is hypothetical in nature and is not indicative of any
particular investment. Past performance is not indicative of future
Potential Downsides of IRA Rollovers to Consider
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 cannot be readily taken in many
circumstances. Also, you must begin taking distributions from an
IRA by April 1 of the year after you reach 70½ whether or
not you continue working, but employer-sponsored plans do not
require distributions if you continue working past that age.
Remember, the laws governing retirement assets and taxation are
complex. In addition, there are many exceptions and limitations
that may apply to your situation. Therefore, you should obtain
qualified professional advice before taking any action.
Points to Remember
- Retirement plan assets that are scattered among numerous
accounts may be difficult to manage effectively, with
hard-to-assess portfolio allocations and risks.
- Lump-sum distributions are immediately taxable as ordinary
income unless rolled over into another tax-qualified plan within 60
- IRAs generally offer more flexibility in estate planning than
- Employer stock can be treated differently from other assets in
a lump-sum distribution in order to harvest the benefits of
long-term capital gains tax treatment.
- IRAs may offer less protection in personal bankruptcy than
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