A period of transition
The current economic and market environment has prompted many Americans to rethink their retirement strategies. If you are experiencing a job transition — particularly if the transition is unplanned and unexpected — such a reassessment may be particularly important for you. While it may be tempting to focus more on your immediate needs, you should not lose sight of long-term goals, especially your retirement strategy.
Because your employer-sponsored retirement plan represents a key source of future retirement income, it is important to carefully consider your alternatives for administering these assets. During a job transition, you will usually have three options: take a lump sum distribution; leave your assets in the employer-sponsored plan; or move your assets into a Rollover IRA.
By taking a lump sum distribution, the assets in your plan are distributed directly to you, providing you with immediate access to your funds. Depending on your short-term needs, that may appear to be an attractive alternative. However, a distribution will likely result in substantial federal and state income taxes and a 10 percent penalty tax, which can significantly reduce the amount of the distribution.
Because you will be receiving the distribution directly, the plan administrator must withhold up to 20 percent of the value of the distribution for federal income tax purposes. Moreover, you will lose the benefit of the tax-deferred status of these assets, which could reduce the amount ultimately available to you at retirement.
If you decide to do nothing and leave your assets in your former employer’s plan, the tax-deferred status of your assets will be protected and you will be allowed to transfer the account assets at a later time to a new employer’s retirement plan that accepts rollovers. But you may be limiting your investment choices and control, because employer plans typically have a restricted investment menu and require the consent of your spouse before you can name someone else as a beneficiary.
A Rollover IRA simultaneously addresses the issues of taxation, flexibility and control, and may hold significant benefits:
• If your distribution is transferred directly to a custodian, rather than to you, the Rollover IRA eliminates the withholding requirement and penalties that may result from a lump sum distribution.
• The entire rollover amount can be invested immediately, according to the strategy you specify.
• Your assets and any earnings continue to have the potential to grow tax-deferred until you retire and begin taking withdrawals.
• You may gain access to a wider range of investment options and more retirement planning and distribution flexibility.
• You can name any beneficiary, including a trust, without needing the consent of your spouse (although special rules may apply in community property states).
Benefits of consolidation
You also may want to consider consolidating other similar assets, such as multiple IRAs you may have opened over the years and account balances you may have left in the plans of former employers. Together, these assets may represent a significant sum, and there are some good reasons to consider consolidation:
• It can be difficult to maintain an effective investment strategy — one that accurately reflects your goals, timing and risk tolerance — when assets are spread among multiple financial institutions. When you consolidate, your financial professional can help you ensure that these assets are part of your overall asset allocation strategy that is reflective of your current financial situation and long-term retirement goals.
• A self-directed IRA generally offers you the ability to choose from a wide range of investment products, including stocks, bonds, mutual funds, annuities and more.
• It is easier to monitor your progress and investment results when all your retirement savings are in one place, because you will receive one statement instead of several. That simplifies your life while protecting the environment.
• Reducing the number of accounts also may reduce your account fees and other investment-related charges.
Dealing with one account rather than several also simplifies the distribution process, including complying with complex minimum distribution rules when you reach age 70-1/2. And you avoid the risk of losing track of your retirement accounts or access to the account assets should your former employer merge with another company or go out of business. You may find that this time of transition holds benefits for your retirement assets.
Donald E. Sommese, first vice president and financial adviser based at the Manchester office of Morgan Stanley Smith Barney, can be reached at 800-726-6141.