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Qualified Plan Rollovers: The Next Frontier

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The qualified plan rollover market is hardly new. For example, Larry Klein, a registered investment advisor, says rollovers have represented 40% to 50% of his business since the late 1980s.

But rollovers are definitely cutting edge, where business opportunity is concerned, say experts. Therefore, they say, financial advisors and companies should be taking steps to enter this market now, if they have not already done so.

“Its a huge and growing market for advisors,” contends Klein, who is president of NF Communications Inc., Walnut Creek, Calif.

More and more baby boomers will be hitting retirement age in the next 5 to 10 years, he explains. In addition, due to the new work patterns and economic pressure, more people are changing jobs and/or dealing with layoffs, so they need to decide where to put the money from their former retirement plan.

This money includes assets in 401(k), 403(b), 457 and other defined contribution programs at the employer.

Some financial executives have told National Underwriter that rollovers already are counting for increased sales. The large majority of sales are said to be in individual retirement accounts containing mutual funds and other investments. However, some sources report that 20% to 30% or more of their rollover sales are going into IRA annuities (fixed or variable annuities inside an IRA wrapper).

Rollovers accounted for about $188 billion in assets in 2002, according to Financial Research Corp., Boston (see related article on page 5).

Not all players contacted by NU are seeing rollover sales blossom, but most expect the rollover IRA market will open wide, and soon.

Rollovers are “perfect for people who want to leverage their qualified plan money as tax efficiently as possible,” explains Angelo J. Robles, president, Northeast Wealth Advisors, Stamford, Conn.

The problem right now, he says, is that “I dont think average clients or advisors are yet knowledgeable about the products or how the products can help meet client needs.”

Another problem, he says, is that some advisors believe a brisk rollover market is too far off to prepare for now. “There is some truth to that,” he agrees, noting that most boomers will not start retiring for a few years and that some are even delaying retirement.

However, says Robles, this is the time for advisors to start helping clients understand their retirement needs and how they will handle their rollover accounts. “The advisor needs to show clients how to get what they want, so their customers dont have to work longer or reduce their expenses” in order to get by.

The advisor also needs to start focusing on building client relationships, learning clients emotional buttons and talking with clients about how to prepare for long term care expenses, he says.

Finally, Robles says, advisors need to become educated now on rollover products so they help clients who change jobs choose the best option regarding their existing 401(k). “The average worker today will have at least 7 job changes,” he notes.

Thats important to keep in mind, say experts, because clients often blame the advisor for not informing them about the issues involved.

People often do not understand the tax issues or the importance of tax deferral, explains James G. Russell. He is vice president-qualified plan and tax reduction service at Filomeno & Company, a CPA and business advisory firm in West Hartford, Conn.

They may not realize, for instance, that “if they take the money as a lump sum (rather than rolling it over), the employer will withhold 20% to cover the taxes due. Then, if they decide they want to have all their money continue growing in a rollover IRA, they will have to find a way to come up with the 20% to make up for the shortfall.

“Many also dont know about the additional tax they will have to pay if they take their money before age 59.5. Or, they think that their financial distress is a reason for an exception, when it is not.”

When clients later learn these things, “they become upset–not at their former employer but at their advisor,” continues Russell. “They say, No one told me about this.”

His advice? Be sure to tell clients about these things, “and when you do, always have it in writing, that you did provide this information.”

These education efforts may be coming none too soon. A recent report from Hewitt Associates, Lincolnshire, Ill., shows that nearly half–or 42%–of 160,000 employees who took 401(k) distributions in 2002 cashed out their 401(k) plans when they changed jobs.

Only 52% rolled the money into an IRA, and just 6% moved it into the new employers plan, Hewitt says.

That 42% figure is “shocking” and “disturbing,” says Tom Simpson, national sales manager for Ameritas Variable Life Insurance Company, Lincoln, Neb. It is especially so because that figure includes older workers (in their 40s and 50s) as well as a lot of young people, he says.

Those who are advising departing employees may not be asking the important questionssuch as who will spend the moneyor providing suitable education, Simpson suggests.

Also, when considering products in which to place the rollover funds, some employees and advisors are not aware of how rollover products have been changing in recent years.

For example, some people will not consider rolling their money into an IRA with a variable annuity due to perceptions that may be inaccurate, he indicates. These perceptions include the belief that rollover VAs have high fees, redundant tax deferral, and insufficient disclosure on fees and features.

The tax deferral is redundant, he conceded, but newer designs are coming out that have lower fees and a pay-by-the-feature-selected structure.

Ameritas, for example, offers a VA suited to the IRA the rollover market with an average expense of 156 basis points a year (including fund expenses), says Simpson. “This competes with no-load mutual funds and is still tax deferred,” he contends. There is full disclosure on this, he adds, and the VAs modular structure enables clients to pay for the surrender charge option they want.

Advisors who enter the rollover market “need to know that the paradigms in products are changing,” he concludes. With the new designs, “sometimes the VA is the appropriate tool to use.”

Product suggestions for this market vary widely, says Robles. “For instance, you can use mutual funds, annuities, hedge funds, private accounts, separately managed accounts, bond and bond funds, and individual stocks.” Also consider how single-premium immediate annuities, reverse mortgages and long term care insurance might fit in, he says. “And dont forget that the client has Social Security coming in. Thats guaranteed money.”

But first, “be sure you understand the full picture,” he adds. “You need to know what is best for the client.”

“You almost have to have a degree in therapy, to become a great advisor in this market,” quips Klein. “You need to focus on managing the relationship, not the money.”

As for the plan details, the skilled advisor needs to become educated on tax and estate planning issues that can complicate rollovers, says Klein.

They also need to be aware of the differences between using mutual funds and annuities for rollover IRAs, say experts. “About 70% of our rollover business is in IRAs with mutual funds and 30% in IRAs with annuities,” notes Richard Ford, senior vice president-marketing and sales development at Plan Member Securities Corp., Carpenteria, Calif.

Many of his firms clients are people who are price sensitive and relatively investment savvy, and they opt for plans with lower costs. “That usually means using mutual fundsand downsizing the risk of the portfolio as the person ages,” Ford says.

But some clients are looking for a stable retirement income, Ford adds, and they want assurance. “So we offer them annuities.” These are good options, especially today, he says, because “many insurance companies have become creative in the rider benefits they offer, sometimes offering life, growth and income protection all in one rider.”

One annuity product in particularthe equity index annuity with a built-in high water markcan be effective for certain older clients, says Russell. “If the person passes away, the beneficiary gets the high water mark amount, even if the account value is down at time of death,” he explains.

There are costs for this, but Russell says when he spells them out, clients who want guarantees are receptive. But he cautions that if a client might need to access the money via early withdrawal, the EIA may not be appropriate due to the costs involved.

Klein prefers to use market investments for rollovers rather than annuities. Most of his clients resist the income feature of annuities “because there will be nothing left when they die,” he says. And they dont like paying the fees for features they may not use.

So, Klein will often use bonds and preferred stock as the safe money options inside a rollover IRA. And he uses other investments as fit the client profile.

Russell looks for investments that are not tax efficient. This might be taxable bonds, mutual fund that throw off huge capital gains or even real estate investment trusts. Inside the rollover IRA, all the gains are tax deferred, he explains, so “the money grows quicker and we get better returns.” Then, as the client ages, he switches to more conservative options.

“Remember,” says Robles, the rollover IRA may not always be the best option. For instance, if the person stays in the old 401(k) or elects to roll the money into the new 401(k), the person gets the advantage of the 401(k)s creditor protection.”

Reproduced from National Underwriter Life & Health/Financial Services Edition, December 5, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.