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Retirement Planning > Retirement Investing

Is a Rollover Right for Your Client? 5 Factors to Consider

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I’ve rarely met an advisor who saw an opportunity for a rollover they didn’t want to take.

In many situations, rolling a retirement plan into an IRA makes sense, especially when the client is switching jobs or retiring. IRAs also offer more flexibility and control than employer-sponsored plans.

However, rollovers aren’t always advisable. Advisors can’t meet their fiduciary requirements by blindly recommending rollovers. What happens when you advise against rollovers? Let’s look at some factors that support leaving your clients’ money inside of retirement plans instead of recommending rollovers.

1. Distribution Options

Many employer-sponsored retirement plans offer more distribution options than just a lump-sum distribution amount. By law, defined benefit plans must offer an annuity form of distribution. While many 401(k)s don’t offer an annuity or pension-style distribution option, if the plan has multiple distribution options, they should be reviewed before taking a lump sum.

Some of the lifetime distribution options available from a qualified retirement plan are significantly better than anything you could purchase for your client on the open market or inside of an IRA. By taking a lump sum and doing a rollover, you might leave a lot of value on the table, harming your client’s retirement security. Before any rollover, make sure you understand the distributions options your client has available in their employer-sponsored retirement plan.

2. Investment Fees

Many IRAs have become cheaper with some trading commissions at large custodians going to $0 on ETFs and single stocks. Additionally, fee compression has brought down the cost of many investment options. In general, though, large 401(k) plans tend to have the lower investment fee costs and plan costs. Firms like Vanguard released data that show their large 401(k)s have some of the lowest investment fees in the industry. Rarely do 401(k)s have trading commissions, but trading fees are still more likely inside of an IRA. And if you’re looking to wrap your planning fee on the new assets in the IRA, it could add a new cost to your client.

3. Company Stock and Net Unrealized Appreciation

If your client has company stock with significant appreciation in an employer-sponsored retirement plan, review the net unrealized appreciation (NUA) strategy before doing a rollover. NUA allows the owner to receive long-term capital gains on certain investment growth of employer stock from an employer-sponsored retirement plan.

However, the rules are very strict, and you’ll lose the benefits if you roll over the employer stock to an IRA first. Learn how to help your clients capitalize on NUA.

4. Backdoor Roth

Roth IRAs have annual income limits that can prevent someone from directly contributing. “Backdoor” Roth IRA contributions are one way to bypass these income contribution limits. The basics of this strategy is to contribute to an IRA as non-deductible contributions and then convert the non-deductible amount over to a Roth IRA. However, this strategy isn’t very effective if your client has a sizable amount of taxable money in IRAs.

5. Age 55 Exception

I’ve run into this exception recently, and it deserves attention. If your client is retiring between the year they turn 55 and 59.5, consider leaving their money in a 401(k), so they have another way to tap into money without being subject to the 72(t) 10% penalty tax. If your client leaves their employer in the year they reach age 55 or later, the client can take a distribution directly from the 401(k) without penalty instead of having to wait to age 59.5. However, if the 401(k) money is rolled over to an IRA, the client could have to qualify for another exception to the early penalty tax or wait until 59.5 to avoid it.

Advisors can’t be fiduciaries if they recommend rollovers to every client in every case. Every advisor should have a rollover recommendation best practice and process they follow to make sure they’re working in the best interest of the client.

— Check out The Mega Backdoor Roth IRA and Other Ways to Maximize a 401(k) on ThinkAdvisor.

Jamie HopkinsJamie Hopkins is the director of retirement research at Carson Group and a finance professor of practice at Creighton University Heider College of Business. Previously, he was a professor at the American College of Financial Services, where he helped co-create the Retirement Income Certified Professional (RICP) designation.


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