Over $350 billion in 3.5 million retirement accounts roll over annually (source: Cogent Research 2011). That's a lot of money from a lot of people in a lot of plans. In approaching this market as a financial professional, it's important you know key strategies for helping ensure rollovers are smooth transitions.
Common instances when a client may consider a retirement plan rollover include when they:
- Retire
- Change jobs
- Receive part of a spouse's plan
- Have a retirement plan terminating
- Elect an in-service distribution from a plan
- Inherit money as beneficiary of a plan
- Have multiple plans from multiple employers
Do you have clients considering a rollover opportunity? If so, alert them to five sharp strategies.
1. Organize plans One sharp strategy is to organize retirement plans.
For example, imagine buying a beautiful blooming shrub, carefully planting it and regularly tending to it by watering and weeding. Come the next year, you plant a new one, and that first shrub receives a bit less attention. The year after, you plant yet another new one, and the first gets even less attention. You may even barely notice it's there. And as a result, it suffers neglect and isn't as attractive as before.
The same can happen when minding retirement monies. The more plans one has, the more challenging it is to manage them all and keep them healthy and growing. Sometimes, plan materials sit in moving boxes from two or three jobs ago and quarterly statements go unopened. Less attention is paid to plan rules … plan choices … and plan results.
It can be hard for clients to tend to all the elements in their financial landscape. Consolidating with a rollover can help. It can create a more organized, purposeful retirement plan, allowing more time for actual retirement planning.
2. Minimize taxes Another sharp strategy is to minimize income taxes.
Imagine a back yard as a retirement portfolio. IRAs and employer-sponsored retirement plans are the trees in it. Ideally they are left to grow for years, in hopes they will be big and strong and bear the fruit of income benefits come retirement time.
Now imagine if the IRS was to trim back some of that growth before retirement income was needed.
That may be the added challenge of saving for retirement outside a qualified plan. Doing so may trigger current taxes on money being accumulated for long-term needs. And if that happens, lost to taxes are both retirement funds and opportunity for future growth on those funds.
Taking a qualified plan distribution in cash may allow immediate spending needs to be addressed, but such an action does come at a cost. Cashing out a distribution:
- Incurs a 20% withholding tax (the portion of the taxable amount that the previous employer must withhold for federal income taxes);
- Incurs current income taxes (at ordinary income tax rates);
- Incurs a 10% tax penalty for early withdrawal if the recipient is under age 59½; and
- Reduces opportunity for potential future tax-deferred accumulation
Rolling over a qualified plan maintains its potential for tax-deferred growth. Because taxes aren't owed until withdrawals are taken, tax-deferred money receives the benefit of triple compounding:
- The original principal earns interest.
- The interest earns interest.
- The money that would have been paid in taxes earns interest.
The benefits really add up over time. They allow money to grow faster than in a currently taxed alternative earning a similar return. So it's important to make sure any rollover opportunity preserves these advantages.
3. Optimize diversification choices A third sharp strategy is to optimize diversification choices — with true diversification.
Some clients may think they're diversified simply because they have multiple retirement plans. Multiple plans don't make for automatic diversification. Are similar options always selected, even in different plans? Even though names may differ, in form and function they may be more duplication than diversification.
Let's return to our yard to see why this is a risk. Say all the trees in the yard are ash trees that have thrived for years. Why change? Well, there's an insect called the ash borer. And it is destroying ash trees by the millions. So if a yard has only ash trees — no matter how well they've done or for how long — they may all be at risk. But with a diversified variety of trees, one risk, specific to one type of tree, won't devastate them all.
That's the point of diversification. It spreads dollars among different choices subject to different risks. That's not to say diversification assures profits or eliminates loss. But it may help manage volatility. And thus a retirement plan – just like a grove of trees – may be better positioned for overall long-term health.
4. Prioritize risks A fourth sharp strategy is to prioritize financial risks.
Being in a position to enjoy a worry-free retirement requires recognizing the risks that can impede progress.
