You Built Your Retirement Plan or Financial Nest Egg.....Now What?

For most people we talk to, the Retirement Plan or 401(k) nest egg will be the largest amount of money they have ever had in one place. For the sake of this article, let’s refer to 401(k)'s as Retirement Plans (RP's). That way, everyone who has one of the other IRS codes for retirement savings plans will continue to read on as well. As an example, teachers and nurses may have a 403(b) available to them through their place of employment. There are 457 plans for Government employees, and the list goes on and on.

This article will look at all Retirement Plans (RP's) as one. In almost all instances, you have at least three options when you have decided that you have worked your last day.

1. In mostRetirement Plans (RP's), you have the election of a lump sum withdrawal from your plan.

This option is by far the most liquid of the three because you will physically walk away with a check in your hand. However, the check will be much smaller than it has to be. You will end up paying income tax on the full distribution. For example, add $200,000.00 (or your 401(k) balance) to your income this year and see how much of it you get to keep after taxes. Also, if your less than 59 ˝ years old, you will write another check for 10% as a penalty and send it to Uncle Sam (he does appreciate your business). I really only bring this option to the table because it is in fact an option that is available. When it comes to retiring and living the rest of your life as financially comfortable as possible, it helps to know all your options.

There is a big fear that the only one who cares about your money is you. Though there are some financial professionals out there that would be politely labeled as bad eggs, the vast majority of financial advisors will truly have your interests at heart. I would caution you to (as they say in the movie “All the President Men”) follow the money. When someone asks you to make a change to your nest egg accounts or your portfolio, why are they asking for that change? Make sure that it benefits you as much as (if not more than) it does your financial professional.

2. The second option is to do nothing at all, and leave it with your old employer.

This is the second most common way people will handle their Retirement Plan (RP) decision at the time of retirement. They will work for 30 years, build up a nest egg with an employer, and then . . . do nothing. You could call this the “deer in the headlights” option, because it is really nothing more than the lack of a decision.

It should be pointed out that there are some very valid reasons for remaining in your current plan. We will tell you these reasons because we want you to do the right thing for yourself and your family. Most financial advisors will lean toward one option almost all of the time, the Rollover IRA, which we will discuss next. In our opinion, there are really only three reasons an ex-employee would want to leave his RP assets with his ex-employer.

A) Between the Ages of 55-59 ˝ at the age of Retirement/Separation of service

This is plausible because of: The Rule of 55. This rule states that if you are 55 years of age or older, you may remove Retirement Plan (RP) assets without the 10% penalty normally associated with a distribution prior to the age of 59 ˝. In an IRA, you are stuck until 59 ˝, but in most RP's, if you were 55 or older when you left the company, regardless of reason, you may have access to your Retirement Plan assets without the dreaded 10% penalty. There is one major caveat with this rule: you are NOT permitted to “age into” the rule. Simply meaning, that if you leave or retire before your 55th birthday, you lose the ability to take penalty free withdrawals until you reach 59 ˝.

B) You have an outstanding loan against your Retirement Plan (RP) balance

If you have been able to borrow from your RP and are in the process of paying it back, you should always leave your assets in the plan until you are debt free. The RP loan is a great discussion for another article, but for now let’s focus on why it is important to leave your assets in the RP if you have a debit balance against it. If you were to move your assets to an IRA, your loan would default. A defaulted RP loan simply means that the loan amount (which was borrowed from your own equity) is now considered taxable income. Retirement Plan loans are able to avoid taxes because you are leveraging the equity, or ownership, in your RP. As soon as there is no equity behind the loan to stand as collateral, the IRS says it is time to pay the taxes due on the loan as a distribution. Therefore, the loan amount left unpaid would be added to your taxable income for the year. Less than 59 ˝ years old? The 10% rule would apply on top of the taxes you would be paying for the increase in your income. Even if the loan had been taken out, let’s say two years ago, and you rollover to an IRA now, it is taxable in the year the RP is distributed.

C) Your investment choices aren't available anywhere else

Once in awhile, you may come across a mutual fund that is truly at the top of its game and is a consistent performer. It is becoming more and more common that these funds are being closed to new investors by their managers. This is done to slow the rate at which money is coming into the fund so that they can invest the money congruent with their philosophy and not lose some of its return by having tons of cash just sitting in low interest paying money market accounts. If you decide to roll your Retirement Plan (RP) into an IRA, this is almost always done as a cash transaction. Your company's plan sponsor (Fidelity, for example) will send you a check made payable to the financial institution. This check isn't taxable because it is made payable to the company and not yourself. Once you have that check, and try to buy back into the funds you were in, it is possible to be “shut out” of the mutual fund in which you wish to be involved. In order to avoid this inability to buy the world’s best mutual fund, retirees may wish to stay put with their retirement money to take advantage of their favored money managers.

3. Rolling your Retirement Plan to a Rollover IRA

Finally, we will close with the most common option for retirees and their RP assets, the Rollover IRA. A Rollover IRA provides an efficient way to get the most bang for your retirement buck. This option easily gives you the most control of your assets both during and after your lifetime. Most RP's have stipulations that do not allow the assets to transfer to your contingent beneficiaries in a tax-advantaged fashion. It is common for RP's to allow only spouses to open a tax-advantaged account with them. Non-spousal beneficiaries are often at a huge disadvantage. In most instances, the RP will require these be paid as cash distributions to the children (or your Trust) as taxable income. If you have your RP beneficiary set as your trust, a child, or any other non-spousal beneficiary, you should move the assets to a Rollover IRA tomorrow . . . ok, today. Besides the great beneficiary options, you will have the world of investment products at your fingertips. Retirement Plans are notorious for allowing its participants to choose from 10-15 investment elections. If you have more, you are lucky. Most brokerage firms today offer virtually unlimited mutual funds, bonds and CD's, as well as the ability to own any stock on the market. Depending on the type of firm you are looking for, you can do these transactions for a very minimal fee. Most on-line firms will have you trading stocks for less than $20.00 per transaction. Rolling over to an IRA is not considered a taxable event, so there is no punishment from the IRS for you to take advantage of all the benefits of a Rollover IRA.

This decision isn't one to make lightly. Depending on whom you talk to you will get different opinions on what the “right” answer is. Ultimately, there is only one answer that matters; the one where you fulfill your goals and sleep well at night. If you got that going for you . . . you are going to be OK. Most people spend thirty years working to retire, and about two years preparing for it. We hope this information has shed some light on the many options that are available when it comes to be your turn to punch that time-clock for the last time.

We wish you well with your Retirement Plan decision!

*the above information was accurate as of April 2006. Company-sponsored plans may have characteristics different from those described above. It is always best to consult your plan representative before making a decision on your retirement plan. Your plan will have literature explaining each of the items discussed above. The above is not intended to give specific investment advice or to speak for all retirement plans. Please check with your specific plan for more details regarding questions for your plan. Copyright www.aging-baby-boomer-guide.com 2006