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ON THE MONEY: Yea or nay to IRA rollovers

December 9, 2018

If you are approaching retirement age, you are going to soon be faced with some important decisions regarding the employer-sponsored retirement plans that you are currently participating in.

First things first – if you have been a participant in a defined benefit plan, you should do two things: first, be thankful that you have been in such a plan, since you will receive a guaranteed monthly income stream you cannot outlive. The second thing that you should do is to meet with the plan administrator to determine what your distribution choices are. Defined benefit plans provide, typically, an amount of monthly retirement income that is based on your income during employment and your years of credited service with that employer. Assume that your monthly retirement income will be $3,000 per month, based on a life only annuity option (the typical option).

This option provides no guarantees of payment duration, so that if you were to die one month after retiring, your spouse would receive no further retirement income from that plan. Bummer. To prevent you from unknowingly disinheriting your spouse, the Feds now require him or her to sign off if you elect an annuity payout that does not include a spousal residual monthly benefit. Remember that providing some spousal residual will reduce the amount of monthly income you will receive while you both are still living, since your combined life expectancies are greater than your individual life expectancy. In such a case, your monthly income might drop by 10-15 percent, or to $2,550-$2,700.

If the reduction is 25-30 percent or more, and you are in good health, you might consider purchasing life insurance with a portion of the additional income you would receive from the life only option. In so doing, your spouse would receive a tax-free death benefit at your passing.

Another important question to ask your plan administrator is does your defined benefit plan provides a cash distribution option? If it does, you might be able to generate more monthly income by electing the cash distribution and then purchasing an annuity yourself from an insurance company. Doing so will not engender any negative tax consequences.

If your company plan is a 401(k) plan, you may have the option to leave your accumulated funds in the employer plan, and this choice may be best if the investment choices are good and if the administration expenses are low. Otherwise, there may be some tax advantages to be gained by transferring your accumulated assets directly to an IRA. The preferred method to do that is to establish the IRA account with a financial institution and then instruct your company’s 401(k) plan administrator to send your account balance to your new account. Otherwise, if you take the distribution yourself in the form of a check, your plan is required to withhold 20 percent of the total distribution, even though you plan on rolling over the amount to your IRA account. You will eventually get that tax money back, but not until you file your tax return for the year in question and get your refund.

If you are age 70½ and still working, there is a big advantage in leaving your accumulated dollars in the company’s 401(k) plan, and that is that you don’t have to take any Required Minimum Distributions from the plan so long as you continue to work. One other plus for not rolling over is that your 401(k) plan values are protected from lawsuit judgements, while IRA values are not.

Depending on the provisions of the 401(k) plan, it may be possible for any beneficiary to have death benefits paid over his or her life expectancy. If the plan does not provide that option, then rolling over will make sense. The trap to avoid is bequeathing your IRA monies to your children and grandchildren as a group, and not earmarking amounts for each person individually. If you don’t name each beneficiary individually, the amounts that each child must withdraw each year will be based on the life expectancy of the oldest beneficiary.

I recommend that you leave your IRA assets to your spouse, and then she or he can leave any remaining monies to your children and/or grandchildren. A spouse is treated, literally, as royalty when it comes to the distribution options that are available to her or him regarding inherited IRA assets.

Another plus for the IRA rollover is the ability to establish separate IRA accounts for all your beneficiaries, each with a different investment strategy – conservative for your wife and more aggressive for the kids.

Distribution planning is important, so consult a qualified professional if you have questions.