By Mitch DeWitt
Dan Corcoran – the newest member of the Walkner Condon team and social media/marketing extraordinaire – and I were having a casual conversation over coffee one morning, and we naturally turned to the topic of sports. Dan has a background in social media and marketing in the semi-professional hockey space, and I have been a lifelong sports fan, primarily rooting for my Michigan Wolverines and the Detroit professional sports teams (it has been a rough time to be a sports fan in Detroit lately). Dan mentioned the recent ESPN layoffs, which I was previously unaware of. It’s safe to say that most sports fans probably grew up watching SportsCenter and have tuned into ESPN to catch our teams’ games at some point. Being the financial advisor that I am, I thought of the financial planning opportunities and the considerations of rolling over a former employer’s retirement plan. Being the marketing guy that Dan is, he told me to write a blog. (By the way, if you’re one of the many folks who have lost a job over the last few months, here’s another helpful blog about working through a job loss).
So, before we go any further, what is a rollover? The IRS defines a rollover as the following: “A rollover occurs when you withdraw cash or other assets from one eligible retirement plan and contribute all or part of it, within 60 days, to another eligible retirement plan.” Sounds pretty straightforward. But there are many rules about what types of accounts can be rolled over and what types of accounts are acceptable destinations. Furthermore, there are some tax traps that people can fall into. If done correctly, a rollover of tax-deferred assets should not be a taxable event. Unfortunately, I’ve seen “do-it-yourselfers” attempt to roll over their assets from a former employer’s retirement plan and have realized a large and unexpected taxable event. This is where we come in: to help people advise on their options with their retirement plans, make a decision on their best course to align with their retirement goals, and then confidently execute the plan.
If I got laid off, what are my options with my retirement plan / 401(k)?
Roll it over to another qualified plan or IRA
The IRS publishes a rollover chart to show what they would deem an acceptable rollover. In many cases, we find ourselves interpreting this chart and educating our clients on where they can roll their retirement assets as well as what makes the most sense for their situation. Again, if done correctly, a rollover should not be a taxable event (unless you want it to be in the case of a conversion. More on this in my next point). Many people come to me saying that they want to “consolidate” their accounts or “transfer” their accounts. This presents another education opportunity with clients, since a transfer is treated differently than a rollover. A transfer typically refers to the same type of account moving from one institution to another (e.g. Roth IRA at Fidelity to a Roth IRA at TD Ameritrade), whereas a rollover refers to moving assets from one type of account to another (e.g. 401(k) at Fidelity to a Rollover IRA at TD Ameritrade). Furthermore, there are direct rollovers and indirect rollovers. Direct rollovers are where your assets are sent from one custodian to another (e.g. Fidelity to TD Ameritrade). No taxes are required to be withheld when a direct rollover is performed. An indirect rollover is where you do take possession of your assets during the rollover process. In this case, you are required to withhold taxes from the distribution amount. To avoid paying taxes on an indirect rollover (and ensuring that the amount withheld isn’t included as taxable income), you must deposit your assets into another qualified plan or IRA within a 60-day period. You also must ensure that the amount distributed from the original account (including the withheld amount) is fully deposited into the new account. Generally speaking, direct rollovers are preferred to indirect rollovers because withholding is not required. You will receive a 1099-R for the tax year that you conduct a rollover. Rollovers are reportable to the IRS even though they are not taxable. A 1099-R is issued whether the rollover is direct or indirect. However, in the case of an indirect rollover, it is up to the taxpayer to prove that they properly rolled over their assets to avoid a taxable event (when they file their tax return).
Convert it to Roth
You may be able to convert all or a portion of your tax-deferred assets in your retirement account. Converting your tax-deferred assets to Roth will be a taxable event. Some might wonder why you would want to do that. Let’s say someone might be in a lower tax bracket in the current tax year vs. a higher tax bracket when they take money out of the account in the future. The thought is that if it is going to be taxed at some point, why not tax it at a lower rate? We help many clients analyze their different “buckets” that their assets are in: taxable, tax-deferred, and after-tax (there are technical differences between “after-tax” and Roth, but that is beyond the scope of this blog). Depending on the situation there might be a reason for a client to spread out their assets between the three buckets or it might make sense to heavily favor the Roth bucket, for example. If the client’s circumstances align to make a Roth conversion, it may occur all at once or over a phased approach over several tax years. This is something that should be coordinated between a financial advisor like us and a tax advisor.
Keep it where it’s at
Many plans will allow you to keep the assets in your 401(k) (or similar retirement plan). Although they are able to force you to move the balance out of the plan, usually if there is a less than a $5,000 balance in your account. You might want to do this if you like the investment options, the fee structure, or simply the convenience of not having to take any action.
Cash it out
Yes, this is an option, but in most cases it’s not recommended because of a potentially large tax bill. Additionally, it may be detrimental to your financial plan and ability to obtain retirement goals. Usually, the only time this makes sense is when someone finds themselves in an unexpected and dire financial situation.
It is worth having a conversation with us if you find yourself in a situation where you have been laid off or even if you have several outstanding 401(k) accounts spattered across different retirement plans and financial institutions. We would love the opportunity to educate, offer some guidance, and eventually help execute your plan. You can reach out directly to us here, so we can get the conversation rolling (pun intended, I couldn’t help it).