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July 18, 2024 at 01:16 PM
What You Need to Know
- IRA rollovers are generally best, but there are times when a lump-sum distribution makes sense.
- With its new fiduciary rule, Labor wants advisors to explain which distribution option best fits a client.
- Employees with large holdings of their company's stock might want to take advantage of net unrealized appreciation — but there's a critical mistake for advisors to avoid.
While an IRA rollover is the best move for most people when distributing money from a 401(k) plan, there is a special case when a lump-sum distribution makes sense — and the justification for one is “bigger than ever,” according to tax and IRA expert Ed Slott of Ed Slott & Co.
On a recent video chat with Morningstar’s Christine Benz about the Labor Department’s new fiduciary rule, Slott relayed that Labor is attempting to prevent advisors from making a “knee-jerk default to the IRA rollover because they will do better with that because they have assets under management they get paid on.”
Labor, Slott said, wants advisors to get educated on each option for an old 401(k) and to have a process in place to explain the best of three options for distributing the assets in the plan.
The three choices, Slott explained, are “roll it over to an IRA, leave it in the company plan, or if you get a new job, roll it to a new company’s plan — but it’s essentially the same thing because it stays within a 401(k) — or take a lump-sum distribution and pay the tax.”
Why would you leave money in a company plan? “Generally, that’s not the best move; the IRA rollover is the best move for most people,” Slott said.
Labor, Slott continued, wants advisors to communicate with the employee that has a 401(k) the pros and cons of each option.
Slott counsels advisors to tell clients, “You have the IRA rollover. That’s generally the best,” he said. “If you don’t see advantages in the other two, by default, that’s probably the best option.”
When a Lump Sum Makes Sense
Benz noted during the video that the lump-sum distribution option, or take “the money and run option … should be marked with a skull and crossbones, like don’t ever do it.”
Slott responded, however, that there is a reason to take a lump sum, “and it’s bigger than ever.”
The lump-sum distribution is where advisors tend to not know enough, according to Slott.
“With a tax break in employer securities called net unrealized appreciation, you can turn what otherwise would be ordinary income rates — because if you take money out of an IRA, it’s regular job income, ordinary income,” Slott said. “This turns that same income, if you qualify, to long-term capital gain rates, which can be half, if you know about it.”
