Investing

IRA Rollovers: A How-To

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Individual retirement accounts, or IRAs, are the most popular savings vehicle in America for a good reason: They represent a flexible, tax-advantaged and (usually) relatively simple-to-manage vehicle in which to set aside money for retirement.

IRAs held about $7.4 trillion in retirement funds as of the end of 2014, more than any other type of retirement account, according to the Investment Company Institute. But alas, IRAs are governed by a sometimes-complex set of tax rules, especially when transferring money to, from and between accounts, moves commonly termed IRA “rollovers.” Running afoul of the rules means potentially losing the flexibility, simplicity and tax-favored status that make IRAs so appealing. Read on to learn how to preserve those advantages and spare yourself major rollover headaches.

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What is an IRA rollover? What does the process entail? An IRA rollover is a process by which the owner of a retirement account instructs the custodian or trustee managing that account (such as a mutual fund company) to distribute a specified amount of money from the account for the purpose of rolling that money into another separate account.

There are several general types of rollovers: (1) from one traditional IRA to another traditional IRA; (2) from a traditional IRA to a retirement plan such as a 401(k) or 403(b); (3) from a retirement plan such as a 401(k) or 403(b) to a traditional or Roth IRA.

Before undertaking an IRA rollover, it’s important to get up to speed on IRS rules that govern the process, says Nate Wenner, a certified financial planner™ (CFP®) and certified public accountant with Wipfli Hewins Investment Advisors in Edina, Minn. Those rules specify the process to which rollovers must adhere to avoid triggering a taxable event, along with the types of distributions that can be rolled over (called “eligible rollover distributions”).

Before executing a rollover involving a retirement plan such as a 401(k) or 403(b), also familiarize yourself with the rules and conditions governing distributions to or from that plan (depending on whether you’re rolling funds from the plan, into an IRA, or vice versa).

What are some of the reasons to consider an IRA rollover? Rollovers can happen by choice or be triggered by an event. Here are some of the most common reasons they occur:

  • Separation from employment, such as due to job loss or retirement, whereby the person may need to execute a rollover because they’re no longer eligible to participate in their former employer’s plan.
  • To take advantage of broader or different investment options and/or lower investment fees with a different IRA or plan provider.
  • To consolidate numerous accounts with one custodian/trustee/plan to simplify portfolio management, etc.
  • When taking a new job, where it may make sense to rollover an IRA you have from a previous employer, into one offered by your new employer.
  • When a current employer that had not previously offered a retirement plan begins offering one.
  • To capitalize on the greater flexibility and access to funds that traditional IRAs tend to offer compared to some other types of retirement plans, according to Wenner.

What are the biggest pitfalls associated with IRA rollovers? The foremost concern in undertaking an IRA rollover, says Wenner, is ensuring the maneuver is executed according to IRS rules to avoid triggering a potentially costly taxable event.

The most important rules to know in this context apply to custody of the distribution (the funds) to be used in the rollover. Will that money transfer directly from one account custodian/trustee to the other account custodian/trustee? Or, will the distribution go to the account owner (typically the person in whose name the account is held), for them to eventually deposit in the new account to finalize the rollover?

The safest way to avoid a rollover-triggered taxable event, says Wenner, is to specify a direct custodian/trustee-to-custodian/trustee transfer, where the account holder instructs the custodian/trustee of one account (the one from which the rollover money will come) to directly transfer funds to the custodian/trustee of the account into which the funds will be rolled. Essentially the account owner removes themselves as the middle person by instructing the relevant financial institutions or plan administrators to handle the transfer directly. In doing so, be sure to contact the relevant institutions and/or administrators so you’re clear on how they intend to handle the transfer and what they may require from you to expedite it.

Since in this case there is no formal distribution to the account owner, there should be no taxable event to worry about — if the transfer is properly executed. The key here is to be sure the account holder specifies to the custodian/trustee that they want the money to be transferred directly to the other custodian/trustee on their behalf. In many cases that’s as simple as asking the custodian to make the check payable to the new custodian for the benefit (“FBO”) of you.

Otherwise, if the rollover distribution check from a plan or IRA is made payable directly to you, solely in your name, the amount may be subject to a withholding tax of 10% (for distributions from an IRA) or 20% (for distributions from a retirement plan).

Though it’s not always advisable given the risk of triggering a taxable event, in some cases the account owner may take custody of the funds earmarked for a rollover (i.e., the custodian makes the distribution check out in the name of the account owner), with the intent of ultimately depositing that money into another account to execute the rollover.

Under IRS rules, when the money from an IRA or retirement plan is distributed to the account owner during the rollover process (rather than transferred directly from custodian to custodian), the account owner has 60 days to deposit the rollover amount into another eligible plan, without triggering a taxable event. In this case, a distribution sent to the account owner in the form of a check payable to the receiving plan or IRA is not subject to withholding. However, the onus is on the account owner to get that rollover amount deposited into the other account within 60 days. If that doesn’t happen, the account owner likely will be on the hook to pay income tax on the amount of the distribution, in addition to a penalty if they’re under age 59½.

Three key takeaways:

 

  1. Take the direct transfer route and know the transfer rules that apply to the specific type of rollover — those of the IRS as well as those of the specific custodians/trustees/plans involved in the transfer.
  2. In the case of a direct transfer, be sure you’re clear whether the custodian/trustee/plan intends to send you a check made payable to the other custodian/trustee/plan, for you to forward, or if they will directly transfer your funds to the new custodian/trustee/plan.
  3. If they’re sending you a check in your name (again, not the optimal route in most cases), be sure to deposit that amount promptly into the other retirement plan or IRA account — and absolutely within the 60-day IRS limit.

 

Where can I go for help executing an IRA rollover? Begin by visiting the IRA/retirement plan rollover page of the IRS website at:

http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Rollovers-of-Retirement-Plan-and-IRA-Distributions. Then consult a financial professional to help walk you through the process. To find a Certified Financial Planner™ (CFP®) professional in your area, check out the Financial Planning Association’s national database at www.PlannerSearch.org.

 

October 2015 — This column is provided by the Financial Planning Association® (FPA®) of Northeastern New York, the principle professional organization for Certified Financial PlannerTM (CFP®) professionals. FPA is the community that fosters the value of financial planning and advances the financial planning profession and its members demonstrate and support a professional commitment to education and a client-centered financial planning process. Please credit FPA of Northeastern New York if you use this column in whole or in part.

The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION. The marks may not be used without written permission from the Financial Planning Association.

Are Alternative Investments Right for You?

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If the financial crisis of several years ago taught us anything, it is that the traditional stocks-bonds-and-cash investing model may no longer adequately protect many investors from devastating losses in their investment portfolios.

That realization has prompted a surge in the popularity — and availability — of so-called “alternative” investment strategies and vehicles. These alternatives give investors another means to diversify their investment portfolios and thereby to protect those portfolios from downside risk while also hopefully providing a measure of growth on the upside. At least that’s how the reasoning goes.

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But because alternative instruments can be complex and opaque in how they operate, because some have limited track records, because they often do not behave like traditional stocks and bonds do, and because some may carry investment minimums, they’re not suitable for everyone. Indeed, given these factors, it’s imperative that investors do their homework before deciding to invest in any kind of alternative vehicle. “You definitely want to consult with a financial professional who’s knowledgeable in this area,” says Tom Balcom, a certified financial planner at 1650 Wealth Management in Lauderdale-by-the-Sea, Fla., “and doing some research on your own can also be helpful.” Balcom also holds a Chartered Alternative Investment Analyst designation.

As a starting point for that research, here’s a quick primer on alternatives:

WHAT are alternative investments? In broad terms, alternatives are investments in asset classes that aren’t directly linked to traditional stocks and bonds, according to Mark Wilson, co-owner and chief investment officer at Tarbox Group, a wealth management firm in Newport Beach, Calif. The financial and investment research firm Morningstar defines alternatives as investment strategies or asset classes that have low correlations to traditional stock and bond investments, with unique sources of risk and return and thus, the potential for a superior risk-adjusted return in a portfolio.

Vehicles such as managed futures funds, long-short funds, hedge funds (and funds of hedge funds) as well as hedge fund replication strategies and commodities are just some of the varieties that fall into the broad and nebulous definition of alternative investments.

WHY to consider investing in alternative asset classes (and WHY NOT)? In most cases, the chief motivation for investing in alternative assets classes is to mitigate the potential for volatility and risk inside an investment portfolio by diversifying with investments whose behavior does not correlate to the behavior of stocks and bonds. “It’s about diversifying to reduce downside risk, to dampen volatility so you get a smoother ride, and to earn positive absolute returns within a portfolio,” explains Balcom.

Alternative investments do come with unique risks. They may not perform as advertised or expected, notes Wilson. Some can be more gimmick than substance. Some are illiquid, meaning an investor may not be able to promptly and simply sell their stake in an alternative investment when they wish to. Some come with high fees and/or costs to the investor. Some are more tax-efficient than others.

WHO is a good candidate to consider alternative investments (and WHO ISN’T)? Alternative investments should be at least a consideration for most investors, according to Balcom. Likewise, Wilson says he uses alternatives with virtually all his clients (most of whom are wealthy). However, he notes, people with less than $100,000 in their investment portfolio might be best served focusing strictly on stocks, bonds and mutual funds.

HOW to access alternative asset classes? Once the exclusive domain of institutional investors (such as pension funds, educational endowments, etc.) and the ultra-wealthy, alternative investments have become accessible to the mainstream via readily available mutual funds and exchange-traded funds (ETFs). In fact, mutual funds and ETFs that invest in alternative asset classes have become one of the fastest-growing segments of the industry.

WHICH alternatives to consider? That depends on a person’s circumstances and mindset as an investor. However, given the many varieties and potential complexities of alternative investments, Wilson suggests gravitating toward those that have a clear performance track record along with a clear investment strategy and structure. Look for transparency.

HOW MUCH should you invest in alternative asset classes? Again, it depends on your investment profile and priorities. One rule of thumb from Wilson: “You want to own enough where there’s a real benefit to it” — where your portfolio includes a high enough percentage of alternatives to effectively dampen volatility and limit downside portfolio performance when stock and bond investments head south. Among Wilson’s high-net-worth clientele, alternatives typically represent 15 to 25 percent of portfolio value, he says.

WHERE to turn for insight and guidance? Is an alternative investment suitable for you, given your investment profile? If so, which type of alternative asset class, and specifically which kind of vehicle or strategy, might be most suitable to your situation, goals and risk tolerance? Because these aren’t easy questions to answer, it’s best to consult a financial professional with a strong background in “alts” for guidance. To find a Certified Financial Planner™ (CFP®) professional in your area, check out the Financial Planning Association’s national database at www.PlannerSearch.org.

 

August 2015 — This column is provided by the Financial Planning Association® (FPA®) of Northeastern New York, the principle professional organization for Certified Financial PlannerTM (CFP®) professionals. FPA is the community that fosters the value of financial planning and advances the financial planning profession and its members demonstrate and support a professional commitment to education and a client-centered financial planning process. Please credit FPA of Northeastern New York if you use this column in whole or in part.

The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION. The marks may not be used without written permission from the Financial Planning Association.