The current economic and market environment has prompted many Americans to rethink their retirement strategies. If you’re experiencing a job transition—particularly if it’s unplanned and unexpected—such a reassessment may be particularly important for you. While it may be tempting to focus more on your immediate needs, you shouldn’t lose sight of long-term goals, especially your retirement strategy.
Basic decisions. Your employer-sponsored retirement plan is likely to be a key component of your retirement strategy. Because it represents a key source of future retirement income, it’s important to carefully consider your alternatives for administering these assets. During a job transition, you’ll usually have three options: Take a lump-sum distribution, leave your assets in the employer-sponsored plan or move your assets into a rollover IRA.
Taking a direct, lump-sum distribution. With this option, the assets in your plan are distributed directly to you in a lump sum, which provides you with immediate access to your funds. Depending on your short-term needs, that may appear to be an attractive alternative. However, a distribution will likely result in substantial federal and state income taxes and a 10 percent IRS penalty tax, which can significantly reduce the amount of the distribution. Because you’ll be receiving the distribution directly, the plan administrator must withhold up to 20 percent of its value for federal income tax purposes. Moreover, you’ll lose the benefit of the tax-deferred status of these assets, which could reduce the amount ultimately available to you at retirement.
The status quo option. You can decide to leave your assets in your former employer’s plan. That will protect the tax-deferred status of your assets and let you transfer the account assets at a later time to a new employer’s retirement plan that accepts rollovers. But you may be limiting your investment choices and control, because employer plans typically have a restricted investment menu and require the consent of your spouse before you can name someone else as a beneficiary.
Establishing a rollover IRA. A rollover IRA simultaneously addresses the issues of taxation, flexibility and control, and may hold significant benefits for you as a result:
• If your distribution is transferred directly to a custodian, rather than to you, the rollover IRA eliminates the withholding requirement and penalties that may result from a lump-sum distribution.
• The entire rollover amount can be invested immediately, according to the strategy you specify.
• Your assets and any earnings continue to have the potential to grow tax-deferred until you retire and begin taking withdrawals.
• You may gain access to a wider range of investment options and more retirement planning and distribution flexibility.
• You can name any beneficiary, including a trust, without needing the consent of your spouse (although special rules may apply in community property states).
Investment products in an employer plan are usually limited to mutual funds and company stock. With a self-directed rollover IRA, you can work with your financial professional to structure a portfolio using stocks, bonds, annuities and other investments using an asset allocation (which doesn’t assure a profit or protect against loss in declining financial markets) that’s customized to help you meet your retirement investment objectives. And your retirement strategy can be further tailored with a wider range of beneficiary selection and distribution choices.
Consider consolidation. This may also be an excellent time to deal with multiple IRAs you may have opened over the years, and with account balances you may have left in the plans of former employers. Together, these assets may represent a significant sum. Following are some good reasons to consider consolidating them all in a rollover IRA.
Comprehensive investment strategy. It can be difficult to maintain an effective investment strategy—one that accurately reflects your goals, timing and risk tolerance—when assets are spread among multiple financial institutions. When you consolidate, your financial professional can help you ensure that these assets are part of your overall asset allocation strategy that’s reflective of your current financial situation and long-term retirement goals.
Greater investment flexibility. A self-directed IRA generally offers you the ability to choose from a wide range of investment products, including stocks, bonds, mutual funds, annuities and more.
Simplified tracking. It’s easier to monitor your progress and investment results when all your retirement savings are in one place, because you’ll receive one statement instead of several. That simplifies your life while protecting the environment.
Lower costs. Reducing the number of accounts may also reduce your account fees and other investment-related charges.
Dealing with one account rather than several also simplifies the distribution process—including complying with complex minimum distribution rules when you reach age 70.5. And you avoid the risk of losing track of your retirement accounts or access to the account assets should your former employer merge with another company or go out of business. Your financial professional can help you assess your alternatives so you can make decisions based on what’s best for you. You may find that this time of transition holds benefits for your retirement assets.
Edward Choe is a financial adviser at Morgan Stanley Smith Barney in San Rafael. You can reach him at (415) 482-2714 or http://fa.smithbarney.com/edchoe.
Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Smith Barney Financial Advisors do not provide tax or legal advice. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their personal tax or legal advisers to understand the tax and related consequences of any actions or investments described herein.
