On our last posting, we explored when an individual should consider rolling over their employer sponsored retirement plan (QRP) and while there are plenty of situations in which a rollover to an IRA makes sense, there are other situations where a rollover is not recommended.
Let’s look at a few situations when it might make sense to keep it where it’s at:
When Not to Rollover
Protection from creditors—while both IRAs and QRPs enjoy some protection from the claims of creditors, QRPs including SEPs, SIMPLEs, and 403(b) plans are entirely exempt from claims of bankruptcy creditors. While IRAs and Roth IRAs enjoy an exemption of up to $1 million, which can be increased, depending on the state, in the case of rollover IRAs from QRPs, the $1 million limitation does not apply. While it’s safe to say that many states, including Wisconsin, allow at least a partial exemption of some types of IRAs from the claims of judgment creditors, you should seek the advice of their legal counsel when it comes to such matters.
QRP holds appreciated employer securities—Appreciated employer securities in a qualified plan account enjoy special tax treatment if distributed in lump sum. In a case such as this, you are taxed on an amount equal to the plan’s basis in the securities, but the “net unrealized appreciation” in the securities as of the date of distribution is not taxed until the securities are sold. At the time you sell the securities you are taxed at the capital gains rates that year (currently 15 percent), not ordinary income tax rates, which can run as high as 35 percent in 2011. On the other hand, if the lump sum distribution of appreciated employer securities is rolled over to an IRA, the NUA advantage is lost, and distributions from the IRA will be taxed as ordinary income.
Access funds after reaching age 55 (but before age 59½)—If you are eligible to receive a distribution from an employer’s QRP at age 55 or thereafter, a distribution following termination of employment is includible in income but there is no 10 percent penalty on the distribution. If you have separated from employment and therefore you are no longer an “active participant”, most plans allow for a “one-time distribution, allowing you to take a partial distribution (only once though, any further distribution will have to be the remaining balance). On the other hand, if you roll the funds over to an IRA, then take a distribution, the penalty applies until you reach age 59½ (unless another exception is available, such as Section 72(t)).
Access to funds via loan—an additional consideration for those of you who might need access to the funds is whether the QRP permits loans. Loans can be offered to participants in a QRP but not to IRA owners.
Divorce—Both IRAs and QRPs can be divided pursuant to a divorce decree without triggering income to plan participants. Furthermore, if the non-participant ex-spouse (or other beneficiary) receives distributions from a QRP pursuant to a Qualified Domestic Order (QDRO), the distribution is taxable to the beneficiary but no penalty applies, even if the beneficiary has not attained the age of 59½. On the other hand, if distributions are made to an ex-spouse or other beneficiary from an IRA prior to the beneficiary attaining age 59½, the distribution is included in income and the 10 percent penalty applies (unless some other exception is available).
Conversion to Roth IRA—In most respects, beneficiaries of IRAs and QRP have parallel rights when it comes to rollovers. However, there is one key difference—a non-spousal beneficiary of a QRP can convert the plan account directly to an inherited Roth IRA, but a non-spousal beneficiary of an IRA cannot do so.
The IRA rollover is a powerful planning tool. But it is made even more powerful when it is used in the right situation with your goals and objectives in mind. Make sure you discuss your options with your advisor before making a decision.