Best practices for retirement plan rollovers

It’s unclear how rollover opportunities will look in the finalized version of the Labor Department’s fiduciary reproposal, but that doesn’t mean plan advisers can’t provide some basic education on distribution options.
Indeed, industry observers were less than thrilled to find a provision in the Labor Department’s conflict of interest rule, which permits investment education for participants but requires that it not include advice or recommendations on specific investment products, managers, “or the value of particular securities or other property.”
“They have proposed to take away the ability to say in an enrollment meeting, ‘Here’s an example of a conservative portfolio,’” Brian H. Graff, chief executive of the American Retirement Association, said at a May 14 virtual conference held by the American Society of Pension Professionals and Actuaries.
“If you name specific investments that the participants have access to, by naming them, they’re saying that that’s a fiduciary act,” he added.
But advisers who want to improve their services to plan participants might want to talk to them about rollover education at a basic level.
“We suggest a three-pronged strategy,” said Matt Sommer, vice president and director of retirement strategy at Janus Capital Group Inc. “Regardless of how this proposed regulation ultimately ends up, these are some best practices that advisers can adopt today that can put them in a good position to service participants.”
Education on net unrealized appreciation. Employees might own highly appreciated shares of the company they work for, and they may have low cost basis — meaning that they had acquired those shares very cheaply. When the time comes to part ways with the employer, the employee has a choice: take the shares in an “in-kind” distribution or roll everything over into an IRA.
The difference is that if the employee goes with an “in-kind” distribution and deposits the shares in a taxable account, he or she will owe ordinary income tax only on the cost basis of the stock and a 10% penalty if under age 59½. If the employee were to sell the shares at some point in the future, he or she faces long-term capital gains taxes on the net unrealized appreciation — the difference between the cost basis and the current market value — of those shares.
By comparison, if an employee rolls everything over into an IRA, when the time comes to distribute the assets, they’ll be taxed at an ordinary income rate, usually much higher.
“This is an example where the IRA rollover isn’t the best scenario for the participant,” Mr. Sommer said.
Teach early retirees about the consequences of early distributions from the plan. Generally, plans tend to write out a check to departing employees if their account balance is below $5,000. But those with larger amounts will have to consider whether it makes sense to stay in the plan or leave. There are additional factors to consider if the employee is parting ways and is 55 or over, said Mr. Sommer.
For one thing, those who are 55 and older can take a distribution from their retirement plan without being subject to the 10% penalty on early distributions. Those workers are still subject to income taxes on those distributions, however.
It’s important to note that IRAs don’t have that exception. Early withdrawals from IRAs before age 59.5 are subject to income taxes and the 10% penalty.
Why is it good for older workers to know about this? “One could say that if a participant has an immediate liquidity need, it might be in their interest to leave a portion of the money in the plan, which they can access without penalty,” Mr. Sommer said. “It’s not a new rule. This is just an example of where advisers can separate themselves.”
Education on fees. It’s worth mentioning to employees the nature of fees in a retirement plan, and how those expenses can differ, should the worker roll his or her money over to an IRA. Educate them on the nature of 401(k) expenses. “Fees are more transparent in the 401(k) plan,” Mr. Sommer said. “This is often a function of the size of the plan.”
“The fees will be difficult to match for people who roll out of the 401(k),” he added.
Keep workers who are facing retirement in the know about Medicare and Social Security. In retirement, the rollover out of a 401(k) is only the beginning. Departing employees should get a preview of what’s coming up in this next stage of their lives as retirees. Advisers are in a prime position to educate those participants on Social Security, Medicare and beneficiary designations. “Beyond the simple transactions, what are the ancillary services that advisers can provide?” Mr. Sommer asked.