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March 31, 2012 at 08:00 PM
How old your client is when he decides to roll over his 401(k) could determine whether the entire amount should be transferred.
Today’s 401(k) rollover market has been highly lucrative for advisors, especially with all the people who are retiring or are in transition between jobs. One often overlooked provision of the tax code when performing these rollovers is the pre-age-59-and-a-half, 10-percent penalty exception for those who separate from service in the year they turn age 55 or older. If your client qualifies for this exception, is under age 59-and-a-half, and looking to roll over his or her 401(k) account to a Traditional IRA, you need to question the advisability of transferring the entire balance.
The exception applies only to employer plans, not IRAs. Even though the balance in the IRA might have come from an employer plan, if your client needs to take a distribution from the IRA, barring another exception and they are under age 59-and-a-half, they will pay a 10-percent penalty from that distribution. If a portion of the plan balance was still in the plan, they could have taken distributions penalty-free. Thus, a good strategy to discuss with your client who qualifies for this exception is to calculate how much of their 401(k) funds they might need to use prior to age 59-and-a-half, and then leave that portion in the plan.
Here’s an example: Joe Taxpayer has a $500,000 401(k) plan and is downsized from his company at age 56. He determines that he will need $10,000 per year, or about $36,000 to $40,000, prior to age 59-and-a-half for living expenses. Why not roll over $450,000 (leaving Joe an additional $10,000 just in case) into a Traditional IRA, and leave the balance of $50,000 in the 401(k) plan for Joe to take distributions from prior to age 59-and-a-half?
Does not apply to IRAs
