How to Execute a Well-Timed, Strategic IRA Rollover

How to Execute a Well-Timed, Strategic IRA Rollover

Record numbers of workers in the USA have quit their jobs since April 2021. According to experts like McKinsey & Company, who are calling this phenomenon the ‘great attrition’, the reasons are complex and varied. Burnout is high on the list, as is a widespread feeling that companies lack appreciation for employees, as well as a need for greater flexibility and autonomy at work.

There are any number of consequences associated with this corporate flight, including shifting cultures and a fight for talent, but there is another consideration which hits much closer to work for the individual employee’s future financial well-being: How 401(k) retirement savings are safeguarded during this transition.

A smart and simple way to take control of retirement savings when moving jobs, shifting career trajectories or starting up your own business is to make use of a Rollover individual retirement account (IRA).

A Rollover IRA is no different to a traditional IRA, and is taxed in the same way, but it has a particular role to play when retiring or leaving a company. Of course, it is possible to shift assets without using an IRA Rollover, but this could mean you will lose out on some very real, long-term benefits.

So, in the immortal words of Chuck Berry, let’s dig a little deeper into the subject, “roll it over and move on up”.

To Consolidate or Not to Consolidate?

The first thing to remember when getting to grips with a Rollover IRA is that this form of IRA is designed specifically to handle transfers from an employer-sponsored 401(k) plan. As such, some companies will only accept assets into their employer plan if they come via a Rollover IRA. So that’s something to consider, or to ask if you are moving to a new company.

It is also possible, before moving jobs, for individuals older than 59½ to access a portion of their retirement account by means of an in-service distribution. This enables employees to directly transfer – tax-free – an amount from their employer-sponsored 401(k) into an IRA.

Permission is, however, required from the employer. If the employee is under the age of 59½ then they must provide evidence of some sort of financial hardship, be it medical or educational costs, or even the purchase of a property. It is best to check your 401(k) plan’s summary description to see if this option applies and, if so, the amount you could withdraw using this special provision. Since the full amount cannot be withdrawn using this approach, a Rollover IRA would still be required for the balance.

Once you have a Rollover IRA, you might actually want to keep the funds from your former employer housed in this vehicle. Why? Because any amount contained in a Rollover IRA is fully protected under federal bankruptcy law, while assets held in a Traditional IRA and Roth IRA are only protected up to a certain limit ($1,362,800 per person until April 1 2022).

There are other advantages to consolidating multiple IRA accounts into a single Rollover IRA. These include reduced fees, since each individual account would charge an annual fee, and (when the time comes) making it easier to manage required minimum distributions (RMDs) in order to avoid being penalised by the IRS. A consolidated approach also leads to greater simplicity when it comes to estate planning, which makes it easier for beneficiaries to track accounts.

The Major Pros and Cons of an IRA Rollover

Safeguarding your 401(k) retirement savings using an IRA rollover offers the flexibility and control associated with a Traditional IRA, including the option to select from a range of investment options from stocks and bonds to mutual funds and exchange traded funds.

Although, without the guidance of a skilled investment advisor, this level of choice can be overwhelming for some investors; given that a Rollover IRA is self-directed and requires direct input from the holder. Without a long-term, strategic plan of action, the temptation to micro-manage funds can lead to the erosion of the portfolio’s value and incurring unnecessary trading costs.

Another strategic challenge from a wealth planning perspective is the 60-day period in which to complete the entire process of the IRA rollover. This requires careful planning if funds are released in tranches.

Given that each individual is only allowed one tax-free distribution into an IRA over a 12-month period, there are heavy tax penalties and implications if you choose to go it alone and don’t plan the movement of funds strategically.

Other Common IRA Rollover Mistakes

As with all aspects of saving and investing, it’s critical to apply a personal lens to how you use an IRA Rollover account and ensure that the correct coding is used for tax purposes. Other potential mistakes include:

  • Withdrawing a 401(k) rather than rolling it over – In such cases, the holder will incur withdrawal penalties for drawing out retirement funds. The same applies in the event of an ‘indirect rollover’ which goes through the hands of the holder before transferring to another retirement trustee; thus requiring that you include the amount on your tax return – it will also be subject to the 10% early withdrawal penalty tax.
  • Neglecting your paperwork – Often when moving jobs employees forget to keep track of old employee plan accounts or to rollover funds into an appropriate IRA vehicle. This has long-term implications and results in as many as 30% of all pension accounts simply falling into the ‘lost’ category.
  • Failing to consider all the options – Depending on your particular circumstances, there are other options available for rolling over retirement savings, such as low-fee investment options. However, choosing to veer away from the safer Rollover IRA approach should only be a decision arrived at after extensive consultation with your financial advisor.
  • Not considering RMDs – This could be a costly mistake which triggers an unnecessary tax event if you are required to take a RMD in the same year that you receive the distribution from the 401(k). This applies to those aged 72 and older. Failure to take this into account could result in an excess contribution, which would incur a 6% tax penalty.

A Financial Advisor Can Be a Major Resource

Only recently, the US Department of Labor issued new rules which stipulate the role and responsibilities of financial advisors when it comes to rollover recommendations and ensuring that any advice is in the investor’s best interests. Given the importance of managing the IRA rollover process diligently and strategically, this move is clearly to the benefit of the millions of Americans actively planning for a successful retirement.

If you are looking for an independent, fee-only investment advisor with more than 30 years’ experience and know-how to guide you through the IRA rollover process using simple and straightforward language and logic, or if you need help creating a long-term retirement savings plan, then drop me a line and let’s get rolling.

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Plus receive my free ebook: 5 Simple Ways to Bring the Purpose Back to Your Retirement Plan