IRA Rollovers Complement a
Change of Employment
How often have you
changed jobs in the last 10 years? And with each change, what happened to your
retirement plan?
If you hold a
401(k), 403(b) or other form of employer-sponsored retirement plan, you have a
number of options when you leave a job. (1) You may be able to leave your
retirement account with the plan, although there may be restrictions that apply
to you as a non-employee, (2) You may have the option to transfer your
retirement funds to your new employer's retirement plan, (3) You can roll over
your funds to an Individual Retirement Account (IRA), or (4) You may opt to
withdraw your assets from the plan.
Of the options
above, the most suitable is often an IRA rollover.
Withdrawing your
funds early from a tax-deferred retirement plan is rarely an optimal solution.
If you meet hardship provisions set by your plan administrator and law, you can
withdraw funds without a 10% early withdrawal penalty prior to age 59 1/2, but
the withdrawal is still subject to ordinary income taxes. That can whittle a
$50,000 withdrawal down to $32,500. Add in a 10% penalty and you could lose
nearly half of your withdrawal to taxes. Naturally, if you are in a lower tax
bracket this cost will be less, but it is still substantial. Plus, you lose the
opportunity to build retirement security.
Reasons to leave
your retirement plan with your former employer's plan administrator include if
you don't like the retirement plan structure offered by your new employer or
your former employer has a particularly attractive investment option.
Non-employees do not always have the same options and rights as employees,
however, so make certain you understand how leaving your job affects your
retirement plan status.
Your new employer
may allow you to roll over your existing retirement plan into its plan. But
here again, make certain you understand how the plan operates and your
investment options before you do so. Once you have rolled over into the plan,
your ability to move your funds elsewhere will be restricted.
Rolling over your
retirement plan from your former employer to an IRA can be a much better
solution because it gives you the greatest control over how your funds are
invested and the costs you incur. A Rollover IRA is an Individual Retirement
Account specifically designed for eligible distributions coming from an
employer-sponsored retirement plan. By rolling your money directly from one
retirement plan to the rollover IRA you are able to avoid current taxes and
penalties, while allowing your retirement savings to grow tax-deferred. A
rollover IRA offers a number of benefits:
-
Your investment options are no
longer restricted by the plan administrator. Rollover IRAs can be invested in
mutual funds, exchange traded funds, stocks, bonds, or other securities,
including CDs and Treasuries. Some custodians even accommodate real estate and
limited partnerships. This allows for greater diversification and more
opportunities.
-
You will be able to eliminate
administrative fees that reduce net returns. While plans such as a SEP-IRA are
relatively cost efficient, 401(k) and other employer sponsored plans tend to
have higher administrative costs resulting in part from reporting and
compliance requirements. Eliminating a half a percent charge or more every year
can add up to substantial gains over a 10 to 20 year horizon.
-
With a rollover IRA you have the
ability to consolidate assets from different types of retirement accounts. A
myriad of different employer-sponsored retirement funds can be rolled into one
account, adding up to a better grasp on your overall investment portfolio and
more efficient management.
-
You can add professional
management to a rollover IRA without restrictions. While many
employer-sponsored plans now make professional advice available, there are
often restrictions as to providers and the degree of active management
permitted.
One of the greatest
weaknesses of many employer-sponsored retirement plans is that full investing
responsibility is placed on the employee. With little formal investment
training and a full-time job taking first priority, many employees find their
accounts lagging market indices and the results of professionally managed
pension plans. While some of the difference may be attributable to the higher
fees and charges individual investors tend to face compared to institutional
investors and corporate pension plans, studies show the degree of difference is
significant.
A
2005 study by Mercer Investment Consulting found individual equity investors
lagging the returns of institutional investors and corporate pension plans by
more than 4%.
Recent legislation
has placed IRAs on par with employer-sponsored retirement plans in terms of
protecting assets from creditors and lawsuits. IRAs can also be effective
estate planning tools, allowing accountholders to stretch the calculation of
the required minimum distribution payout until their grandchildren retire.
Another rollover
option made possible with the Pension Protection Act signed into law in 2006 is
the ability to rollover an employer-sponsored retirement account directly to a
Roth IRA effective Jan. 1, 2008. While this requires paying ordinary income
taxes on the rollover amount, all subsequent earnings can be withdrawn free of
federal income taxes.
For more information
on how an IRA Rollover could simplify your finances and help build retirement
security, call today and let's talk.
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It Isn't That
Simple
It's human nature to want to understand phenomena. That need has
led to scientific discoveries, new technologies, psychoanalysis and much more.
But there's also a tendency for "experts" to try to meet the
demand to understand why with overly simplistic answers. How often do stock
market wrap-ups on the evening news have a one bullet explanation - "Stocks
dropped as investors worried about the Federal Reserve's rate decision", or
"went up in response to lower oil prices." the list of rationales goes on and
on.
The same applies to forecasts for the market. Take the January
barometer, for instance. According to an old Wall Street adage, "As goes
January, so goes the year." If the stock market is up during the month of
January, then the January Barometer dictates that the stock market should show
a gain for the following 11 months. From 1950 to 2005, the January barometer
had success rate of 86%.
Or did it? If you look at the number of months when the January
barometer was negative, its accuracy drops to around 50%, i.e. the same as a
coin toss. In fact, much of the accuracy of the January barometer results from
the fact that historically there have been far more up years than negative
ones.
Markets cannot anticipate human behavior and they are not
governed by what is expected to happen. They adjust for what is perceived as
reality at the moment. Sometimes the reason is very simple and very immediate.
But other times the market's move is the result of an accumulation of concerns
and pressures over time.
While we may not be able to predict where the market is going, we
can measure where it is today and what sectors of the market are experiencing
the greatest demand. Then we monitor for changes in that trend and adjust
portfolios accordingly. It's not simple and every trade isn't going to be
right. But the alternative is comparable to leaving the wash out on the line
regardless of the changing weather. When the sky clouds up, you can be pretty
sure that your clothes face the possibility of getting a lot wetter, if they
don't blow away altogether. If you bring the items inside, you can always put
them out again when the weather turns sunny.
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Direct Deposit Your Tax
Refund into an IRA
Looking for ways to increase the amount you save each year?
Consider adding this to your strategies.
If you are likely to receive a refund of taxes you have paid to
the federal government over the past year, arrange to have your refund
deposited directly to a Roth IRA.
Under the Pension Protection Act of 2006, effective January 2007
taxpayers can authorize direct deposit of their refunds from the federal
government to an individual retirement account. The law actually allows you to
direct deposit money from your refund into as many as three accounts. In
addition to a Roth or traditional IRA, the money may be deposited into a
savings account, a checking account or a health savings account. To do so, you
will need to establish the account prior to filing your taxes and then complete
Form 8888 designating where refunds should be deposited.
A husband and wife, filing jointly, may each contribute up to
$4,000 to an IRA or Roth IRA, or $5,000 if 50 or older at the end of 2006. That
adds up to a tidy $8,000 for under 50 couples and a $10,000 contribution for
older investors. If a Roth IRA is used, all earnings will be exempt of federal
taxes. Depending upon the amount of the refund, it can also be used to fund a
health savings account if appropriate or simply to increase taxable savings.
The advantage of using direct deposit of your refund as a cash
flow tool is that it's money you've already written off in a way, so its
investment can be relatively painless! There are income restrictions with
respect to investing in a Roth IRA, do check with your financial professional
before opening an account.
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Giving
It Away Is Easier in 2007
After scrambling to save and build up a solid retirement fund,
it's possible to discover that you have more than you anticipate spending, and
perhaps more than you want to pass on to your heirs. One way to make certain
your excess funds go to causes you support, without incurring estate taxes,
probate costs or lawsuits from your heirs, is to give the money away while you
are still around. The trick is to donate your excess without taking a tax hit.
Thanks to the Pension Protection Act, there is a window through
December 31, 2007 that allows donors 70½ years of age or older to make up to
$100,000 per person tax-free distributions from IRAs for charitable purposes.
Among the advantages of the IRA provision are:
-
The contribution is excluded from gross
income.
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The rollover amount counts against the
donor's minimum required distribution.
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The "qualified charitable distribution"
does not impact the donor's charitable donation limitation. QCDs operate
independently of the percentage limitation rules and, therefore, don't affect
other gifts to which the limitations apply.
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Qualified charitable distributions from
IRAs don't require donors to claim an income tax charitable deduction.
-
Donors who were itemizing
for the sole purpose of claiming deductions for their charitable gifts may
longer need to do so if they fund their gifts from their IRAs. Naturally, there
are limitations.
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The donor must be 70 ½ years of age or
older on the date of the transfer.
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The donor must transfer the funds
directly from the IRA to a qualified charity (trustee to charity transfer).
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Gifts cannot exceed $100,000 per taxpayer
per year; and
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Gifts must be outright. In other words,
transfers to donor-advised funds, private foundations or supporting
organizations, charitable remainder trusts and charitable gift annuities do not
qualify.
Before taking making a
qualified charitable contribution, you should consult your tax and/or financial
advisor about the best ways to take advantage of these new charitable giving
opportunities. Individual circumstances differ, and state as well as federal
tax laws may affect your plans.
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401(k) Retirement Plans
Gain Greater Beneficiary Flexibility
For many years, a single client had her mother as the beneficiary
on her 401(k) plan, reasoning that if she died the retirement plan could
provide her mother with financial security. But there was always one
disadvantage. If the 401(k) passed on to her mother, the assets in the account
would immediately become fully taxable, most likely at the highest applicable
ordinary income tax rate due to the plan balance. In addition to losing a
potential 40% of the account balance to state and federal taxes, her mother
could also pay higher taxes on any existing income received that year,
including Social Security benefits.
The Pension Protection Act, signed by President Bush in August of
2006, changed that. Now all beneficiaries, not just spouses, can transfer
401(k) proceeds to an IRA and withdraw funds either over a five-year period or
over their life expectancy. That reduces the tax burden considerably for the
beneficiary and provides the opportunity for lifetime income. As always, 401(k)
holders can designate multiple beneficiaries for a single plan.
The law also allows non-spouse, non-dependent beneficiaries to
tap into 401(k) funds in the case of qualifying medical or financial
emergencies. In the past, such withdrawals could be made only for spouses or
dependents of the 401(k) owner.
These changes make 401(k) plans even more attractive as an estate
planning vehicle as well as a source of retirement income. If you are not
maximizing your 410(k) contributions, we would encourage you to look at ways to
increase contributions.
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