Retirement Plans

This week’s Slott Report Mailbag discusses some complex, timely issues involving the once-per-year rule and the timing involved with opening a Roth IRA. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure.

1. I have the following question:

I worked for a local company from May 2005 through mid-December 2008. During this period, contributions were made by both myself and my employer into a 401(k). I changed jobs in December 2008, and executed a direct rollover of the 401(k) assets into a rollover IRA in January 2009. I opened a single 401(k) for myself in April 2008 for my sole proprietorship which I owned and operated. I closed that proprietorship in 2009, and rolled the assets of my single 401(k) directly into the same rollover IRA in January 2010. Do the once-a-year rules apply to all of the assets in the rollover IRA so that I cannot convert any of those assets into my Roth IRA this year? I opened the Roth IRA in January 2003.  Read More

In my experience, most 401(k) fiduciaries—like plan committees—have not focused on properly allocating the revenue sharing received by their plan’s recordkeeper. In fact, it is possible that many plan fiduciaries are not aware that their recordkeepers are receiving revenue sharing from the investments, while others may assume that the recordkeepers are handling the matter properly . . . and perhaps also assume that it is not an issue of concern for plan sponsors. Those are dangerous assumptions.

As background, recordkeepers receive revenue sharing (such as sub-transfer agency fees and administrative services fees) from most of the mutual funds used by 401(k) plans. In most cases, the recordkeeper collects those amounts and either takes them into account in setting its fees or, alternatively, directly offsets them, dollar for dollar, against a stated fee. In some cases, the recordkeeper deposits the revenue sharing into an expense recapture account in the 401(k) plan and then pays its fee—as approved by the plan sponsor—from that account.  Read More

We have written in this column many times about the benefits of a Roth IRA conversion. Commencing in 2010 the income limit has been repealed, making it possible for everyone owning a traditional IRA to convert it into a Roth IRA. Participants and beneficiaries with account balances in employer-sponsored retirement plans, such as 401(k)s and 403(b)s, can also convert those funds provided they are eligible to receive a distribution.

While this rule change was hailed by many in the press as a great thing, plenty of taxpayers remain skeptical. Consumers and practitioners are concerned about the possibility of Congress changing the rules at a future point, taking away some of the benefits of conversion. Without a crystal ball, however, it is impossible to know with any degree of certainty if something like that would ever happen.

One of the benefits of Roth IRAs is that no distributions are required to be made during the account owner’s lifetime. Also, provided certain conditions are met, withdrawals from a Roth IRA will be free of federal (and most state) income tax, regardless of whether it is paid to the original account owner or an inheriting beneficiary. The upfront payment of income tax at the time of conversion eliminates the imposition of income tax on the back end. However, a penalty tax could apply if the converted funds are withdrawn from the Roth too soon (i.e. within 5 years of the year of conversion if the account owner has not yet attained age 59 ½).  Read More

Inertia seems to be the new way of thinking about workplace retirement plans. Employers and investment firms recognize that most people just don’t spend a lot of time or effort on their 401(k) accounts, even after three wild years in the financial markets. Many studies paint a similar picture: most 401(k) participants just don’t tinker much with their accounts.

It can be tough to get people, especially young adults and those earning modest pay, to sign up for 401(k) plans, contribute money and manage their investments. However, once they do sign up they tend to put their accounts on autopilot. They generally don’t change their investment elections or increase their contributions, even when their compensation rises. From an investment perspective, this could be a good or bad thing. Only time will tell.

Recognizing that individuals in general do have inertia when it comes to participating and managing their investments, companies that put together 401(k) plans are stressing features that require minimal effort. These may include “automatic” provisions related to enrollment, contribution increases, and suitable default investments if participants don’t make their own selections. Of course, participants always have the option to “opt-out” of these automatic provisions, but studies have shown that most do not, which is not surprising because it would take effort on their part to do so.  Read More

On June 16 the SEC unanimously approved a proposal to incorporate ending asset allocation into the names of target date funds. For example, a 2020 fund might be rebranded as “2020 / 50% Stocks – 20% Bonds – 30% Cash”. I think this is a good move because it may sensitize fiduciaries to the wide disparity in equity allocations at the target date. The selection of a target date fund is a risk decision that matters most at and near retirement. For the most part this selection is made by plan fiduciaries – sponsors and their advisors – as a Qualified Default Investment Alternative (QDIA). Generally speaking, participants do not choose target date funds, and when they do it’s usually one of several allocations.

Importantly, fiduciaries should be held accountable for defaulting participants into anything other than safe assets as they near retirement, since this is the most critical time for locking in lifestyles. We all set our individual courses as we enter retirement, and develop mindsets of comfort with our plans. Disruptions to these plans create extreme anxiety.  Read More

This week the Ed Slott IRA Discussion Forum featured a question about how a Roth recharacterization can impact RMDs. Did you know that it can? Want to know how? Read on to find out…

Roth conversions are all the rage this year, but many of those conversions could be recharacterized, either because the investments drop in value or simply because the retirement account owner had a change of heart. For many, the decision to recharacterize will simply result in the unwinding of a conversion, with no further actions needed. For those subject to required minimum distributions though, the decision to recharacterize will leave IRA owners with an additional step.

It is widely understood that one of the greatest benefits of the Roth conversion is the ability to recharacterize, or undo the Roth conversion. In fact, if you convert anytime in 2010, you have all the way up until October 15th, 2011 to do so. According to the tax code, should you flip the undo switch and choose to recharacterize, the funds are treated as if they had never left the traditional IRA account.  Read More

Tax-free college savings plans and prepaid tuition programs, known as “529″ plans, can be used to buy computer equipment and internet services for college students during 2010. This change was part of the stimulus bill enacted by Congress last year.

Many grandparents and other relatives set up 529 plans (named for section 529 of the federal tax code) to help young people with college expenses. Family members can contribute up to $13,000 a year to these plans ($26,000 for a couple) without incurring gift tax. The money can then grow in the account tax free.

Family members who want to quickly get money out of their estate for tax reasons can “front load” contributions by giving $65,000 right away (or $130,000 for a couple.) Front-loading in this manner will preclude the donor(s) from making any other contributions to the account, or annual gifts to the person for whose benefit the account was established, for five years.  Read More