The Labor Department's recently released investment advice fiduciary standard has highlighted the importance of rollover decisions when it comes to retirement planning.
When most clients think of rollovers, they think of the traditional 401(k)-to-IRA rollover — rollovers that might be employed several times throughout a typical client's career, as they change employers over the years. The IRA-to-401(k) rollover — or reverse rollover — receives significantly less attention.
For some clients, however, moving funds from an IRA to a company-sponsored 401(k) can have its advantages. If the client's 401(k) plan permits IRA rollovers, the reverse rollover strategy can have several key benefits that could help clients maximize the tax value of these pretax retirement savings vehicles.
Key Benefits of the Reverse Rollover Strategy
Almost every client knows that the general rules governing retirement accounts require nearly every individual account owner to begin taking required minimum distributions (RMDs) by age 72 (70½ prior to 2020). Despite this, if the 401(k) allows it, a client who transfers funds to a company-sponsored 401(k) can avoid RMDs if he or she remains employed with the employer that sponsors the plan. (The client can also continue to make contributions to the 401(k).) This is known as the "still working exception."
RMDs from traditional IRAs are always required once the client reaches age 72 — regardless of whether the client has actually retired. For the still-working exception to apply, however, the plan must specifically allow the client to avoid RMDs, and the client can own no more than 5% of the company that sponsors the plan.
The client's target retirement age can also be key to determining whether a reverse rollover is beneficial. For example, penalty-free distributions may be available from a 401(k) as soon as age 55 if the client retires (i.e., "separates from service"). IRAs, on the other hand, require the client to reach age 59 ½ to take a penalty-free distribution unless some other exception applies (such as a first-time home purchase or certain educational expenses).
401(k)s can also provide access to funds in the form of loans, whereas IRAs do not have a loan option.
