You may become eligible to receive distributions from employer-sponsored Qualified Retirement Plans (QRPs) upon termination of employment during your working years or at retirement. The conventional wisdom in either case is to take the distribution as a lump sum and roll it over to an IRA.
However, rollovers are not always the best solution and it’s important to consult your accountant or advisor to find when it is appropriate to Rollover, when to leave the funds with the QRP, or if you should do a combination of both.
This post is the first of a two part series highlighting situations that may indicate what you should do, but again, consult your advisor first!
When to Rollover
Consolidating for Convenience—a rollover to an IRA at retirement can consolidate recordkeeping and administration. Rather than receiving several statements and worrying about investing and de-cumulating across several platforms, you can simplify matters by rolling over lump sum distributions into a single IRA. Furthermore, while it’s not always the case that an IRA offers greater investment choice than an employer’s QRP, the more likely scenario is that it does. In any event, an IRA is almost certain to offer you greater control over when and how distributions will be made.
Funds to pay college expenses—ideally, affluent and high net worth individuals won’t find it necessary to tap assets earmarked for retirement to pay college expenses for children or grandchildren. However, you may be forced to make hard choices. In general, it makes no difference whether a distribution is taken from a QRP or a traditional IRA, the distribution is taxable. However, distributions taken from an IRA to the extent of “qualifying education expenses,” are not subject to the 10 percent early distribution penalty. On the other hand, the education expense exception is not available for distributions taken from qualified plans.
Funds to purchase a home for a first time homebuyer—another exception to the 10 percent penalty available with IRAs but not QRPs is for first time homebuyers. The exception applies only to withdrawals of $10,000 or less, but is available not only for the IRA owner, but for your child, grandchild, spouse, or ancestor. With more and more Baby Boomers entering retirement and finding themselves sandwiched between unemployed children and aging, dependent parents, the IRA difference becomes an important consideration.
Funds for health insurance premiums – again, although it’s not ideal for a laid-off individual to spend his or her 401(k), for those of you facing long-term unemployment and needing health insurance, rolling over 401(k) assets to an IRA and then taking distributions to pay private health insurance premiums may make sense. Assuming you are unemployed for at least 12 weeks, an exception to the 10 percent penalty is available. Although the distribution is, generally, includible in the your taxable income, the premiums are deductible if along with other healthcare costs, they exceed 7.5 percent of adjusted gross income.
We look forward to your comments or situations that you feel are an important factor when deciding to Rollover your QRP or keep it in your previous employer’s plan. Next week we’ll discuss situations when it may prove more effective not to Rollover.