No Need To Rush End-Of-Career Retirement Planning

As retirement approaches, many employees get a call from their employer's human resources department: "Have you decided what to do yet about rolling over your retirement plan money? You only have X days left until your scheduled retirement." In a semi-panic, the workers then frantically call one or more financial advisors, seeking ideas for investing a large amount of money in a hurry. Each advisor offers compelling ideas for investment strategies that will meet the workers' risk-return profile, income needs and tax-saving goals. But as the days to the "rollover deadline" dwindle, it all becomes a pressure-packed blur.

What can you do to avoid this nightmare? Relax! The only real hurry is in your mind - and perhaps in the sales pitches investment vendors are anxious for you to purchase.

A No-Impact Strategy
For a variety of reasons, it may be advisable to move vested money from 401(k)s and other types of company retirement plans at the same time you retire, even though most companies don't require that you do. However, because decisions and pressures tend to pile up at the "retirement event", this may not be a great time to make complex personal planning or investment decisions. The solution is a no-impact IRA transfer, which we define as a transaction in which:

  1. 100% of qualified plan, 403(b) plan and/or 457(b) plan (employer plan) money is directly transferred (from one or more plans) into a consolidated Traditional IRA with no current tax consequence.
  2. Complex decisions about how to invest this money are deferred for a time.
  3. The same basic investment strategy that has worked in the employer plan is continued in the IRA, at least until the dust settles. For example, if you own specific mutual funds in a 401(k) at work, you would attempt to choose IRA investments (after the transfer) with the same or similar objectives. If you participate in an asset allocation strategy at work, you could choose an IRA that offers a similar program.

Why a No-Impact Transfer Works
Rollovers are a competitive business for financial companies, many of which offer specific investment strategies or financial products designed for this market, including asset management accounts, mutual funds, bonds, certificate of deposits and annuities. To win lucrative business, companies emphasize the need to make changes as soon as possible. For example, they may say things like: "Retirement is a new phase of your life and it requires changes." (For related reading, see Moving Your Plan Assets?)

However, this assertion flies in the face of the way many baby boomers are rewriting the definition of retirement; namely, they picture themselves transitioning into retirement through a series of gradual changes over time. Often, there is no definitive point at which retirement begins.

In a no-impact transfer, vested retirement plan benefits move smoothly into a consolidated Traditional IRA without tax consequences or pressure to make immediate changes to your investment portfolio. Once all retirement plan assets have been consolidated into a Traditional IRA, you can take as much time as you need to plan with professional help. If you finally decide that you really need more income or liquidity or less investment risk in the retirement phase of your life, you then can implement those changes in a more stress-free environment and on your own schedule.

Avoiding Six Common Rollover Mistakes
A valuable benefit of the no-impact transfer is that it helps to avoid common mistakes made in handling IRA rollovers, including:

1. Too conservative, too soon. Many employed people in their 50s and 60s have developed suitable retirement plan investment strategies (see Figure 1, below).

Figure 1: Average employer plan asset allocation of participants in their 60s
Source: EBRI/ICA Participant-Directed Retirement Plan Data Collection Project, 2005

Time-pressured rollovers often result in a major decrease in equity participation, with more emphasis on fixed-income investments. Over retirement periods that may last 25-30 years, it may be advisable to reduce portfolio risk exposure gradually, in increments, rather than all at once. Just because a rollover occurs, doesn't necessarily mean you should change an investment strategy that has worked well to accumulate retirement assets. (For more insight, read Determining Risk And The Risk Pyramid and Personalizing Risk Tolerance.)

2. Annuitizing at the wrong time. According to research conducted by Spectrem Group, 11% of all rollover opportunities are converted into annuity payouts. However, timing is important because the amount of periodic income that an annuity will pay out is determined by interest rates at the time of annuitization, and the period over which the amount is annuitized. Also, it often pays to shop around among many annuity providers for the best quotes, and this can take time. Annuitization is usually an irrevocable decision that should be made with the benefit of good advice and without pressure. (For more insight, read Selecting The Payout On Your Annuity.)

3. Taking cash and paying the tax. Spectrem Group research has found that about one-third of all rollover opportunities result in a distribution of cash, with current tax consequences, rather than a rollover or direct transfer. Taking cash can deplete the value of a nest egg and increase taxes in the year of the rollover and after.

4. Making rollovers more complex than they should be. The easiest way to move money from a qualified plan into a Traditional IRA is through a direct rollover. This avoids the 20% federal tax withholding that occurs when the participant receives a distribution and then rolls it over within 60 days.

5. Paralysis and procrastination. Spectrem Group research shows that 16% of rollover opportunities result in money being left in the plan. When money is left in the plan, it often indicates paralysis - an inability to make retirement plans or decisions. Usually, it is possible to find personal IRA investments with lower (and more transparent) fees than those charged by 401(k) plans.

6. Failure to consolidate. Future retirement planning usually is enhanced when a nest egg is consolidated into one Traditional IRA. Investment strategy, income planning, required minimum distribution compliance and Roth IRA conversions all become easier during the owner's lifetime. Consolidation also can make decisions easier for IRA beneficiaries at the owner's death.

A Caveat about Sales Loads
In completing no-impact transfers, try to avoid IRA investments with either front-end or back-end loads. One strategy that often works well is to complete the transfer to a brokerage account IRA with discounted commissions. This account becomes a kind of holding tank until more permanent decisions can be made, perhaps with professional advice. No-load mutual funds, exchange-traded funds and stocks can then be purchased in the brokerage account at minimal transaction cost.

Rollovers between IRAs are allowed once per 12-month period. This restriction does not apply on rollovers from qualified plans, 403(b) plans and 457(b) plans to IRAs.

A Final Word
A rollover received at or near retirement often represents the biggest paycheck that workers receive, yet many people dread the ordeal of having to handle it.

Just because a giant check arrives doesn't mean you have to change your investment profile, tax picture or your budget. By deferring complex decisions until you have the time and clarity to evaluate them, you may increase your chances of securing the retirement of your dreams.