For years, you have saved diligently into your qualified plan – taking advantage of the tax-deferred growth. Hopefully enjoying the compounding effect that time provides.

Your qualified plan, whether it be a 401K, IRA, SEP IRA maybe your largest capital asset. Now that you are thinking about retirement – defined as doing something on your own terms, you ask your shelf, “Now What?”

A little bit of history to set the framework as to how we got to this point. The concept of pension plans in the United States goes back to the colonial militias and the U.S. Army, many of which predated our country’s independence. The first private pension plan goes back 125 years to the American Express Company, a railroad freight forwarder introduced the first pension plan in 1875 in an effort to promote a stable, career-oriented workforce. (1)

These tenants continued through the industrial revolution and into the the 1970s where legislative foundations made participation in pension plans rise to 45%. (2) In 1074 the department of Labor adopted the Employee Retirement Income Security Act (ERISA). This is the main administrative piece of legislation that governs mainly employee retirement plans. Prior to 1978, most companies offered defined benefit plans – where the company was responsible for contributing money on behalf of employees so that they could retire with a calculable monthly benefit.

Since that time, a tide-shift has occurred for many reasons, which is a topic for another post, to shifting the burden of savings to the employee with some contribution made on behalf of the company. This is so profound that the vernacular changed from Defined Benefit (i.e. a dollar amount you will get from your pension) to Defined Contribution or you the employee are on the hook for your contributions for retirement. You are on the hook on trying to figure out how much to save. You are on the hook for figuring out how to convert a lump sum of capital into a lifetime of cashflow to fund your life’s needs.

Nowhere in the ERISA law, does it give you guidance on how to do this.

I contend the Defined Contribution plans in all of their forms are great savings vehicles. That is what they were designed to do – entice people to save with tax benefits during the time when people are in their saving years, but with mandatory taxation during people’s typical retirement years i.e. after 70! Then the word “tax deferred” becomes meaningful! Many people now have a tax problem they never figured on. And it’s permanent!

I also contend that Defined Contributions also leave many people without a roadmap during the most important time of their lives. Savings is easy. Distribution of savings is difficult.

Once you leave your employer, either by choice or other dynamics, you have in general 4 discrete of choices regarding your retirement plans. You can leave it in the plan, you can roll it over to an IRA, you can do a plan to plan transfer (assuming you are going to work for another employer that has a plan) or you can take a distribution. Each of these has benefits and limitations summarized below:

Leave it in the plan: you are limited to the choices of the plan. You might incur potentially higher fees than when you were an employee – it can be expensive for plans to pay for ex-employees that are not contributing to the company. Your former employer must allow you to leave the money where it is as long as the balance exceeds $5,000. You’ll no longer be able to contribute to the account, but you’ll still decide how the existing assets are invested (within the choices adopted by the plan). The company’s document dictates how ex-employees are treated and certain features you had available to you as an employee may not be available. An advantage is you don’t have to do anything.

Roll to an IRA: usually there is not tax or penalty associated with this, there may be higher costs associated with rolling to an IRA but the trade off is a the potential for greater range of investments and more services. You can also combine several qualified plans into one IRA so consolidation is a benefit, this might be especially true if you have many smaller 401Ks at numerous employers. Experts advise against commingling your retirement plan assets with other IRAs you may have set up. Instead, open a separate IRA account, known as a “conduit IRA,” which may allow you to move the funds to a new employer’s retirement plan at a later date. This may be particularly important if you have made after tax contributions to your 401K. However, you should note that rolling to an IRA account reduces the level of creditor protections afforded by 401K accounts.

Transfer to another plan: By “rolling” the money directly to your new plan, you’ll avoid the taxes that could eat away at a cash distribution. You’ll also only have one set of investments to monitor. Even if you’re not immediately eligible to contribute to the plan at your new job, you may still be able to roll over the money right away. You will be limited to the new plan’s investment selections and fee structure. Transfers are generally tax free but may not be available if you are not returning to work or the new company doesn’t have a plan. If you plan to work past age 70 1/2, this option may be beneficial as current tax law at the time of this writing provides an Required Minimum Distribution (RMD) exclusion for assets in your current employer’s plan from RMD withdrawals. However, if you leave your employer at anytime during the year, even on 12-31, and are over your Required Beginning Date, you will have to take your required minimum distribution.

Taxable Distribution: These distributions are typically taxed at ordinary income rates, which can be significant and may incur a penalty unless you are over 59 1/2 or have a qualified exception. This is rarely the best option due to the taxation that occurs. The good part of this is you have cash in your hand.

Lately, the Department of Labor has been focusing on lowering fees within retirement plans across the board to help balances grow faster. I think they are missing the mark. The crisis is not necessarily a fee issue as it is a savings problem. American’s aren’t saving enough and this worries people in Washington.

While fees are an important factor and should be considered in balance with other factors, I contend that what most people have is a complex math problem. How do you take $X amount and make it produce $Y of monthly income that has to keep up with inflation, meet the demands of my spending needs, wants and desires – for the rest of my life, which may be 30 years or more, so I can do what I want on my terms.

No wonder employers and the government don’t want to be involved with this! Everyone is unique, and no one law, regulation, or policy could have any chance of working for everyone. Hence, it is up to you!

Don’t worry, you have resources to help you through this. We help our clients solve this math problem. We explore each option and put customized plans designed to be dynamic and changing as life occurs.

If you find yourself in this situation and need a shepard to help you through the decisions before you, please give us a call.

If you are a client and would like to review the complex details of your plan, please call us and we will walk you through each step as we see have planned.

Sources & Disclosures

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All investing involves risk including loss of principal. No strategy, including rebalancing and diversification, assures success or protects against loss.

Before making a transfer/rollover decision, you should compare your current and prospective account’s features, including investment options and services, fees and expenses, withdrawal options and required distributions, legal protections, and tax treatment.

Past performance is not necessarily a reliable indicator for current and future performance.

(1) Retirement Plans for Small Business 2017 Version by Edward J Bennett pg. 62
(2) Department of Labor Statistics