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IRA Rollovers: A Checklist for Documenting the Discussion

Regulators are clear: Advisors recommending rollover of employer retirement plan assets must provide clients with advice that is fair, balanced, and not misleading regarding their options for these funds.

Helen Modly, CFP, ChFC, 02/20/2014

For once the SEC, FINRA, and the Department of Labor (DOL) are speaking with the same voice when it comes to the recommendation that clients transfer funds out of employer-sponsored retirement plans upon changing jobs or retirement. These regulators are concerned that clients are being encouraged to transfer funds out of these plans without fully understanding the advantages and disadvantages of their choices.

Employer-sponsored retirement plans and IRAs can differ significantly in the investment options and investor services available, fees and expenses, withdrawal options, required minimum distribution requirements, and tax treatment of withdrawals. The unique financial needs, personal situation, and client's desire for personalized services must be evaluated before an informed decision can be made. Because the decision to transfer funds out of an employer's plan is irrevocable, advisors must adopt practices and procedures to ensure that clients are receiving the most appropriate advice for their situation.

Age Matters
If a client is between age 55 and 59 1/2, it is important for them to realize that most employer plans will allow penalty-free withdrawals, while traditional IRA withdrawals during this period are usually subject to the 10% early withdrawal penalty. Clients that are still employed after age 70 1/2 can usually postpone taking their required minimum distributions (RMD) from their employer's plan until they terminate employment, while there is no such provision for delaying the RMD from an IRA.

This can be especially important for retirement plan balances that are part of a divorce settlement to a spouse or an inherited retirement plan. If the spouse is under age 59 1/2, she should probably leave the funds in the employer plan if there is any chance she will need them before she reaches age 59 1/2. For spouses under age 59 1/2 who are inheriting employer retirement plan balances, they can preserve penalty-free access by leaving the balance with the employer (if allowed) or rolling over to an inherited IRA and taking the RMD as an inheritor until they reach age 59 1/2. After 59 1/2, the spouse can convert the inherited IRA to a spousal IRA and postpone any future RMDs until age 70 1/2.

Unique Investment Options
The availability of additional investment options is the classic premise for transferring plan balances into IRAs. Advisors must consider if any unique investment options exist in the employer's plan, such as the G fund in the Federal Thrift Savings Plan (TSP) and Guaranteed Investment Contracts (GIC) in some plans. These options often provide a guarantee against loss of value that may not be available in IRA options.

Fees and Expenses Always Matter
In the past it has been extremely difficult for a participant in an employer-sponsored retirement plan to determine exactly what fees and expenses they are paying. The DOL has made great strides to rectify this by forcing increased disclosure and transparency upon the providers of these plans.

Investors trying to compare fees and expenses still experience challenges in identifying the fees and expenses associated with retail investment options, especially where deferred annuities are concerned. It is important to realize that there may be significant differences in the level of personalized advice and ongoing investment management services between employer plans and other options. Ideally, clients considering rolling employer-plan balances to any investment option you recommend should be able to identify the cost of the investment itself as well as the cost of the services you propose to provide.

Tax Implications
Advisors must be aware of the tax status of funds in any employer's plan. If plan balances contain after-tax contributions it may be possible to roll these funds directly into a Roth IRA with no tax consequences. If there is employer stock in the plan with a low basis, then utilizing a distribution strategy that takes advantage of Net Unrealized Appreciation (NUA) may be very advantageous and will be forfeited if a traditional rollover to an IRA is done.

Helen Modly, CFP, ChFC, is executive vice president and director of investment services for Focus Wealth Management, a fee-only registered investment advisor in Middleburg, Va. Modly has more than 20 years of experience providing wealth-management services. She is a member of NAPFA and FPA. She can be reached at info@focus-wealth.com. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.
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