Business Builders

Change retirement account type

Rollovers

In some cases, clients can benefit from rolling over a 401(k) into an IRA. Having their retirement accounts in one location makes asset allocation and diversification more transparent. It can also mean more investment options as well as lower fees.

 


Stay in a 401(k) or switch to an IRA?

Rolling 401(k) assets into an IRA can make sense when:

  • A client has switched or lost a job and is considering what to do with his or her old 401(k).
  • A client has multiple 401(k) accounts from previous employers.
  • His or her previous 401(k) is not performing to its potential due to limited investment options.
  • A previous 401(k) is overly dependent on one or limited types of investment vehicles.
  • A client’s income or tax situation has changed.

 

Permitted Rollovers
Roll From Roll to
Traditional
401(k)
Roth 401(k) Traditional IRA Roth IRA
Traditional 401(k) Yes Yes (see notes below) Yes Yes (see notes below)
Roth 401(k) No Yes (see notes below) No Yes (see notes below)

 

Traditional 401(k) to Roth 401(k)

  • Clients may perform intra-plan conversions of “qualified” distributions.
  • Clients must include pre-tax dollars in income.

Traditional 401(k) to Roth IRA

  • Clients must include pre-tax dollars in income.

Roth 401(k) to Roth 401(k)

  • Must be completed as a trustee-to-trustee transfer.
  • Client’s new employer must maintain a Roth 401(k).
  • Five-year holding period carries over (distributing plan provides original start date).

Roth 401(k) to Roth IRA

  • After-tax dollars are rolled first during partial rollovers.
  • Five-year holding period from 401(k) does not transfer to IRA.

Roth conversions

As of 2010, anyone with a traditional IRA became eligible to convert it to a Roth IRA. Don’t assume your clients know this. Some of your high-income clients who were previously unable to contribute to and/or convert into Roth IRAs may not be aware of the change.

Clients of any age and income level are eligible to do this conversion, and there is no limit on the amount that can be converted from traditional IRAs and employer plans. This is a great opportunity to initiate a discussion with clients who:

  • May not need the assets in retirement, because a Roth account does not require the owner to take minimum distributions.
  • Earn too much to contribute directly to a Roth IRA.

Tax considerations

In the year of conversion, all pre-tax dollars included in the conversion would be considered income and, therefore, subject to tax. Thereafter, no further taxation applies, unless the client takes a non-qualified withdrawal.

Required minimum distribution (RMD) considerations

A main advantage of converting assets into a Roth IRA is that there is no RMD requirement for the owner—meaning the assets can continue grow without the requirement for withdrawal at a certain age. At the account owner’s death, however, the beneficiary would need to start taking RMDs by December 31 of the year following the owner’s death.

To convert or not to convert?

Discuss the following questions with your clients who are considering converting to a Roth IRA, particularly if they are planning to use the vehicle as part of a generational wealth transfer strategy:

  • Will the IRA be needed to meet the client’s own living expenses or is it intended to be left to an heir?
  • How much tax will be owed upon conversion and will the funds come from the IRA?
  • Does the client plan to use other tax strategies, such as charitable donation carry forwards, to offset taxation of the conversion?
  • What are the current ages of the client and his or her beneficiaries?
  • What is the beneficiary’s “stretch” opportunity strategy?
  • What is the likelihood that the beneficiary will actually “stretch” the IRA? What tax bracket will he or she most likely inherit?