Leaving the Plan
We all know that circumstances change. If you are reading this, you may be contemplating retirement or you may be in the middle of a career change. Whatever your reason for leaving, you have a number of options as to what to do about retirement plan account. These options are dictated by federal law but if you select the wrong one, you could face otherwise avoidable taxes and penalties. For a detailed review of these options and their consequences, please consult IRS Publication 575 at:
http://www.irs.gov/pub/irs-pdf/p575.pdf.
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IMPORTANT NOTE: You are urged to seek competent legal, tax and/or investment advice from a professional advisor. |
The Basics
Distribution of money from a retirement plan account can involve significant legal, tax and investment issues. You should be well informed before making your decision about which distribution option to choose. There are four basic choices open to every plan participant when it comes to distributions from its retirement plan account.
Choice 1: Keep your money in your
current retirement plan account
Choice 2: Transfer your money to a new employer’s
retirement plan
Choice 3: Transfer your money to a Rollover IRA
Choice 4: Take your money in a lump sum distribution
The following information is not intended to constitute legal, tax or investment advice; it is intended to be only educational in nature. You are highly encouraged to seek the advice of a legal, tax or investment professional who is competent in these matters.
Choice 1: Keep your money in your current retirement plan account
This is often the simplest choice since little is required to maintain your account with your current employer. If your account balance is less than $5,000, this option may not be open to you. Please review your Plan's Summary Plan Description (SPD) and contact your Plan's Human Resourcesrepresentative, Richard Peterson, by phone at (480) 899-2994 or via eamil at peterson@sevalleygi.com.
Potential Positives
- Simplicity; little to no action is required on your part.
- Possibly lower investment costs due to economies of scale.
- Your assets maintain their tax-deferred status.
Potential Negatives
- You may be forced out of the plan if you have an account balance of less than $5,000.
- There may be additional administrative/account fees once you leave and become a former employee.
- You are limited to the investments options offered in your retirement plan.
- There may be restrictions or limitations associated with becoming a former employee.
- You must keep your address current with your former employer in order to continue receiving account updates.
Things to investigate
- Are there additional fees once you become a former employee?
- Are there restrictions on your account once you become a former employee?
What do you have to do?
- Most likely nothing is required of you if you meet the minimum asset threshold for your plan account.
- Seek competent legal, tax and/or investment advice.
Choice 2: Transfer your plan account balance to your new employer’s retirement plan
Many people will hold a number of jobs with different employers during their working career. It is therefore common for people to have many retirement plan accounts. But too many accounts can lead to information overload and difficulties in coordinating a cohesive investment strategy. Before you transfer your plan account from one employer to the next, you should weigh the positives and negatives.
Potential Positives
- Simplicity by combining present and future savings into a single account at the new employer .
- The new plan may be a “better” one if it has lower costs/fees and "superior" investments.
Potential Negatives
- The new plan may have “inferior” investments .
- The new plan may have higher costs/fees.
- You are limited to the investment options offered in the new plan.
- Your rollover money may be locked into the new plan until you leave your new employer.
Things to Investigate
- Find out if the new plan accepts rollover/transfer balances (most of them do).
- Compare and contrast your new plan with the old plan.
- Determine if the new plan offers in-service distributions for rollover/transfer monies; this will maintain the portability of your assets even during employment.
What do you have to do?
- Make sure that the new employer accepts rollover/transfer of plan account balances.
- Contact your former employer and complete any paperwork necessary to implement the distribution.
- Make sure that the distribution is handled as a “trustee-to-trustee” transfer.
- Seek competent legal, tax and/or investment advice.
Choice 3: Transfer your money to a Rollover IRA
A Rollover IRA provides the greatest flexibility in terms of investment choices and the freedom to work with whatever institution you wish. You are free to open a Rollover IRA with any institution that provides them. This includes bank, brokerage, insurance and investment advisory firms.
Potential Positives
- Freedom to select who you want to do business with.
- Flexibility to invest in nearly any investment option.
- Ability - if done correctly - to transfer assets back into a new employer’s retirement plan if done properly (but DO NOT commingle with contributory IRA assets).
- Ability - if done properly - to implement advanced distribution strategies (per IRS code 72(t) Substantially Equal Periodic Payments).
Potential Negatives
- Possibly higher fees.
- The difficulty in finding a competent provider to handle your Rollover IRA.
Things to Consider
- Whether the new Rollover IRA satisfies your needs better than the existing retirement plan in which you are invested.
- Explore all costs of the new IRA and compare it with the existing plan.
What do you have to do?
- Open a Rollover IRA with the company of your choice
- Contact your former employer and complete the necessary distribution paperwork.
- Make sure that the distribution is treated as a “trustee-to-trustee” transfer.
- Seek competent legal, tax and/or investment advice.
Choice 4: Take your money in a lump sum distribution
This is the least desirable option for many people. In most circumstances, there are significant penalties for people under the age of 59½ who take lump sum distributions. You should think long and hard before taking such distributions.
Potential Positives
- Immediate access to your money.
- You can still accomplish a rollover to an IRA if you do it within a 60-day period, but please consult with a competent tax professional about this.
Potential Negatives
- Your former employer is required to withhold 20% up-front from your distribution.
- The 20% withholding is rarely enough to pay the full tax amount when due.
- There are significant tax penalties for those people who are younger than age 59½.
- All earnings on your money are no longer tax-deferred.
- You lose the potential for future tax-deferred growth of your money.
- The distribution is a fully taxable event and can push you into a higher marginal tax bracket.
Things to Consider
- Consider whether you REALLY need your money right now.
- Once the distribution is made and the 60-day period is over, your decision becomes final and the cash becomes fully taxable and subject to potential penalties.
- You will never be able to make up the potential lost earnings.
What do you have to do?
- Obtain the distribution paperwork from your prior employer and complete it.
- Remember that you will not receive your full distribution since your prior employer will withhold 20% of it automatically.
- Set aside additional money in anticipation of paying additional taxes for the distribution when you file your next tax return.
- Seek competent legal, tax and/or investment advice.