photo by Τchasty ♥

The Traditional IRA and its offshoots (SEP, SIMPLE, rollover and Roth IRAs) play a leading role in helping millions of U.S. taxpayers invest for retirement.  However, many IRA owners are unaware of the opportunity they have to consolidate their multiple IRAs by using a “Super IRA” strategy (most common is a rollover 401k).  An IRA consolidation strategy can lead to reduced fees and increased buying power.  I’ve had several instances where an individual has had several old retirement plans from previous employers.  That has included defined benefit plans, 401k’s, TSP’s, 403b’s and Keough plans.   The paperwork alone was cumbersome and consolidating has made tremendous sense.

If you like this article, please be sure to also check out 401k Tips: What Not To Do, Rollover IRAs Offer a Wide Range of Benefits, 7 Things To Know About The 2010 Roth IRA Conversion

IRA Consolidation Case Study

The following is a common scenario involving a worker (Patrick) who has changed jobs several times throughout his career.  He has been diligent about saving for retirement, but his assets are scattered.  An IRA consolidation strategy is suggested, and the section concludes with a three-step action plan for investors like Patrick.

Patrick’s Profile:

• Frequent job changer, age 62, is approaching retirement.
• He has lost track of his numerous retirement savings arrangements.
• He turns to his advisor for help with simplifying his financial affairs.

During his career, Patrick has accumulated various retirement accounts but has lost track of the status of each.  He is 62 years old and is thinking of retiring from his current job.  He has three retirement plans with former employers [a profit sharing plan, a target benefit plan and a 403(b) plan], four Traditional IRAs, a SIMPLE IRA, two Roth IRAs, an Individual(k) plan he established when he owned his own business and a Thrift Savings Plan he now has as an employee of the federal government.  He is also the beneficiary of his deceased wife’s nonqualified deferred compensation plan and her Traditional IRA.  In an effort to simplify his life, he turns to his financial planner for help.  This is a strong case for implementing the “Super IRA” consolidation strategy.

Step 1:  Understand the Rules

• A person who owns multiple SEP IRAs and Traditional IRAs can combine them into one “Super IRA” at any time.
• If the person also owns a SIMPLE IRA, he or she can transfer or roll it to a “Super IRA” after participating in the SIMPLE IRA plan for at least two years.  The two-year period begins when the first SIMPLE IRA plan contribution is made to the individual’s SIMPLE IRA.
• A “Super IRA” can receive ongoing SEP plan contributions and annual Traditional IRA contributions.
• Ongoing SIMPLE IRA plan contributions must first be contributed to the participant’s SIMPLE IRA.  If the individual has participated in the SIMPLE IRA plan for at least two years, he or she can transfer or roll over the SIMPLE IRA into one “Super IRA.” (Note: special rollover rules may apply.)
• A “Super IRA” can receive rollovers of eligible assets from all types of qualified retirement plans [e.g., 401(k) plans, profit sharing plans, defined benefit plans, etc.], 403(b) plans, 403(a) plans and governmental 457(b) plans.
• A Roth IRA cannot be transferred or rolled over into a “Super IRA.”  Multiple Roth IRAs can be combined to create a “Super Roth IRA.”  Under the Pension Protection Act of 2006, effective in 2008, participants in qualified plans, 403(b) plans and governmental 457(b) plans can directly roll over eligible plan assets to Roth IRAs if conversion rules are satisfied.
• Spouse beneficiaries of qualified plans and SEP, Traditional and SIMPLE IRAs generally can consolidate their inherited accounts into their own “Super IRA.”

Step 2:  Consider the Potential Benefits of a “Super IRA” Strategy

• Increased buying power, which allows for more sophisticated investment strategies
• One fee vs. multiple fees
• Simplified investment tracking
• Beneficiary organization and consolidation
• Consistent service
• Streamlined paperwork
• Simplified retirement income planning

Step 3:  Work With Your Advisor

Investors should work with their advisors to determine whether a “Super IRA” asset consolidation strategy makes sense for them.

In our scenario, Patrick’s planner asks him the following key questions:

• Do you have the most recent statements from each of your retirement accounts?
• What type of investments do the plans hold?
• Are any of your retirement plans invested in employer securities?
• Is your goal to consolidate your accounts as much as possible?
• How long has it been since you first participated in the SIMPLE IRA plan?

Patrick’s  goal is to consolidate as many of his retirement accounts as he can into one “Super IRA.”  He obtains copies of his most recent retirement account statements to review with his advisor.  He first participated in the SIMPLE IRA plan a year and a half ago.  He does not hold employer securities as a plan investment.

After reviewing the statements, Patrick and his planner determine he could combine the following retirement accounts into a “Super IRA”:

• Profit sharing plan
• Target benefit plan
• 403(b) plan
• Five Traditional IRAs (the four he owns outright and his inherited IRA)
• Individual(k) plan

In another six months (two years after first participating in the SIMPLE IRA plan), he could transfer or roll over that balance to his “Super IRA” as well.  Patrick cannot combine his two Roth IRAs into his “Super IRA,” although he could consolidate them into one “Super Roth IRA.”  And he cannot roll over the nonqualified deferred compensation plan.  Although he could combine the plans as outlined above into one “Super IRA,” it would be best for Patrick and his planner to carefully examine the types of investments currently held by the various plans to see if a rollover is the wisest course of action from a taxation standpoint.  For example, special tax rules apply to distributions of employer securities from qualified retirement plans.  This would be case of NUA or Net Unrealized Appreciation.  Keep in mind, a consolidation strategy may not always be suitable.  An advisor, or a tax or legal professional, can help identify the best course of action to incorporate the best investment services.

Are you candidate for a “Super IRA” strategy?  If so, feel free to contact me and I would be glad to review your situation.

Rollover IRA

The best part about a 401k rollover to an IRA is that it’s much easier than teaching your dog to do the same trick.  Even better is that  compared with employer-sponsored retirement accounts, a 401k rollover can provide you with the broadest range of investment options and the greatest flexibility for distribution planning at retirement. Also, a 401k rollover can typically be operated with fewer restrictions. Here’s a brief overview that highlights some of the key benefits of a rollover IRA compared with an employer-sponsored plan.

As the IRA account owner, you make the key decisions that affect management and administrative costs, overall level of service, investment direction and asset allocation. You can develop the precise mixture of investments that best reflects your own personal risk tolerance, investment philosophy and financial goals. You can create IRAs that access the investment expertise of any available fund complex, and can hire and fire your investment managers by buying or selling their funds. You also control account administration through your choice of IRA custodians.

More Benefits From 401k Rollovers

While you may look forward to a long and healthy career, life’s uncertainties may force changes. Internal Revenue Service distribution rules for IRAs generally require IRA account holders to wait until age 59½ to make penalty-free withdrawals, but there are a variety of provisions to address special circumstances. These provisions are often broader and easier to exploit than employer plan hardship rules.

IRAs are more useful in estate planning than employer-sponsored plans. IRA assets can generally be divided among multiple beneficiaries in an estate plan. Each of those beneficiaries can make use of planning structures such as the Stretch IRA concept to maintain tax-advantaged investment management during their lifetimes. Beneficiary distributions from employer-sponsored plans, in contrast, are generally taken in lump sums as cash payments. Also, except in states with explicit community property laws, IRA account holders have sole control over their beneficiary designations.

401k Rollover Benefits

401k Rollovers Require Careful Planning

One common goal of planning for a lump-sum distribution is averting unnecessary tax withholding. Under federal tax rules, any lump-sum distribution that is not transferred directly from one retirement account to another is subject to a special withholding of 20%. This withholding will apply as long as the employer’s check is made out to you—even if you plan to place equivalent cash in an IRA immediately. To avert the withholding, you must first create your rollover IRA, and then request that your employer transfer your assets directly to the custodian of that IRA.

Keep in mind that the 20% withholding is NOT your ultimate tax liability. If you spend the lump-sum distribution rather than reinvest it in another tax-qualified retirement account, you’ll have to declare the full value of the lump sum as income and pay the full tax at filing time—at a rate of up to 35% depending on your eventual tax bracket. In addition, the IRS generally imposes a 10% penalty tax on withdrawals taken before age 55 from an employer-sponsored plan and age 59½ from an IRA.

Also, if you plan to roll over the entire sum, but have the check made out to you rather than your new IRA custodian, your employer will be required to withhold the 20%. In that event, you can get the 20% refunded if you complete the rollover within 60 days. You must deposit the full amount of your distribution in your new IRA, making up the withheld 20% out of other resources. When you file your tax return for the year, you can then include a request for refund of the lump-sum withholding.

If you have after-tax contributions in your employer plan, you may opt to withdraw them without penalty when you roll over your assets. However, if you wish to leave those funds in your retirement account in order to continue tax deferral, you can include them in your rollover. When you begin regular distributions from your IRA, a prorated portion will be deemed nontaxable to reimburse you for the after-tax contributions.

Don’t Forget Company Stock

Many firms make some or all of their contributions to employee accounts in the form of company stock, bonds or other securities. If you have company securities in your account and their current market value includes significant price appreciation, you could benefit from an in-kind distribution for the company securities that is separate from the lump-sum cash-out of other investments’ assets.

An in-kind distribution is delivery of the actual securities rather than their cash value. The potential benefit comes from the fact that any price appreciation which occurred while the securities were held in the 401(k) can be treated as capital gains rather than ordinary income. When you take an in-kind distribution of your employer’s securities, you will pay income tax only on the original cost basis of the securities; the balance of the value on the distribution date is categorized as net unrealized appreciation (NUA). When you sell the securities, the NUA is treated as a long-term capital gain. Any gain that might occur after the distribution date is taxed as if you bought the securities on the date of the distribution. (Note that NUA treatment is available only for publicly traded securities.)

Drawbacks to 401k Rollovers

While there are many advantages to consolidated IRA rollovers, there are some potential drawbacks to keep in mind. Assets greater than $1 million in an IRA may be taken to satisfy your debts in certain personal bankruptcy scenarios. Assets in an employer-sponsored plan cannot be readily taken in many circumstances. Also, you must begin taking distributions from an IRA by April 1 of the year after you reach 70½ whether or not you continue working, but employer-sponsored plans do not require distributions if you continue working past that age.

photo by Jason York Photography