**As seen on Forbes**
Frank Armstrong, III
American workers that retire or change jobs have been systematically cheated for decades by unscrupulous salesmen posing as Advisors for pension plans. With a tsunami of retirees and an increasingly mobile work force an entire industry is poised to capture pension rollovers. With so many juicy targets of opportunity, it shouldn’t surprise you that abuses happen. But, they don’t have to happen to you.
Perhaps the most egregious of the abuses occur when participants are lured from their 401(k)s into high cost funds or annuities, proprietary products, or other conflicts of interest. IRA rollovers, and the IRA itself are not covered under ERISA’s fiduciary provisions. So, a plan fiduciary is perfectly positioned to gouge a retiree at rollover time.
Often, retirees or terminating employees are simply given the forms by clueless HR departments to rollover their funds into the higher cost IRAs promoted by the plan’s “advisor”. We routinely see annuity contracts loaded down with so called living benefits that charge a total of 3.5% to 4.5% per year with hefty surrender fees that continue for many years. Who benefits? The Advisor of course. Up front commissions are among the highest available in the securities/insurance industry for any investment product.
The Administration believes that costs American investors $17 Billion a year in unnecessary costs and fees.
Finally, the Department of Labor (DOL) stepped up to the plate to protect pension participants and IRA beneficiaries from the very worst abuses. While I characterized the regulations as Fiduciary Light, my main concern is that the regulations don’t go far enough.
It’s a good thing that IRA’s might now be covered by the DOL’s fiduciary provisions, even if the so called “Best Interest Contract” (BIC) exemptions greatly weaken the regulations. But, the problem remains that for every other transaction a registered representative or stock broker is not a fiduciary. The investor is always left wondering what hat the representative is wearing at any particular moment.
The new regulations have been attacked in Congress, and may in fact never be implemented. The SEC is finally looking at their own fix. A new administration might decide to revoke them. In any event, the regs don’t become effective until next year. Meanwhile, it’s still buyer beware and the sharks are circling.
So, if you are changing jobs or about to retire, here’s a simple review of the only four alternatives:
- Take the money, pay all the taxes and penalties then run with whatever balance is left.
- Leave the funds in the old employer plan.
- Roll the money over into a new qualified plan with a new employer.
- Roll the money over into an IRA.
Take The Money and Run
If you take choice number one, there’s no hope for you and you don’t need to read further. You will have given up your favored tax status, paid obscene levels of taxes on your lump sum distribution, open yourself to potential creditor claims, and cannibalized your future retirement.
The tax is calculated on top of whatever other income you might have so it’s at your highest marginal tax bracket. But, it gets much worse. There’s an additional 10% penalty tax on the entire amount if you are under 59 ½.
It’s critical that when changing jobs you do not rob your future security by raiding the 401(k) piggybank. Keep the money in play growing for your retirement years when you will need it.
Leave The Funds In Your Old Employer’s Plan
Choice number two might be attractive if the plan is low cost, and provides great investment choices. You will keep your options open, preserve your federal qualified plan creditor proofing, continue your favorable tax treatment, and keep your money in play building future benefits. Unless your plan is terminating, if you have at least a $5000 account balance your plan can’t force you to take a distribution. So, you don’t need to make an immediate decision. Take your time, study your options and make a good decision. Haste makes waste.
Roll The Money Into Your New Employer’s Plan
If you are moving to a new employer and they have a great plan, you might consider rolling your existing plan balances into it. This may close out the option of a later IRA rollover for those balances, but otherwise has all the advantages of choice two, and it may be easier for you to manage a single account.
Keep in mind that a 401(k) plan usually requires participants to bear the cost of administration, record keeping and investment advice. A few employers subsidize all these expenses, but if your employer does not you probably will not receive any benefit associated with these costs.
By the way, if you really like your new employer’s plan, you can roll over all of your previous employers’ plans and all of your IRAs into it. A major advantage of this strategy is that it consolidates your retirement funds in one spot and makes it much easier to manage.
The IRA Rollover
To be sure, there are great advantages to rolling over your 401(k) when you change jobs, or finally decide to retire. For starters, trying to manage half a dozen retirement accounts spread out among different organizations each with different menu choices and prices is a nightmare. So consolidation done right is generally a good thing.
For most employees choice four, the IRA rollover, will be the best choice. An IRA gives you complete control over the investments selected and the lowest cost possibilities. You may also find that an IRA gives you better control over distributions and beneficiary designations where estate planning is an issue. Done right, this is often the very best option.
Don’t Get Fleeced
Paradoxically the IRA Rollover choice may be the one subject to the most abuse by unscrupulous “advisors”. Today IRAs and Rollovers are not covered presently by the strict fiduciary standards of the Employee Retirement Income Security Act (ERISA). So, predators, unrestrained by fiduciary obligations all too often swoop in to sell expensive, high commission, proprietary, and unsuitable products. For instance, Variable Annuities provide no additional benefit inside an IRA and are typically high cost, high commission, proprietary products which are unsuitable for an IRA but often recommended. And, you would be best served to avoid load mutual funds or other high commission products.
In some cases, pension advisors routinely take IRA rollovers from the pension to put them into higher cost, higher profit IRAs. They may or may not be fiduciaries for the 401(k) but not for the IRA. So as the IRA manager with their Registered Representative or Insurance Agent hat on they are not held to the same high standards.
Your lowest cost choice for an IRA rollover would be to transfer your balance into an IRA with a custodian like Schwab, Vanguard, or Fidelity and then use any of their excellent low cost index funds or ETFs to build a globally diversified portfolio that meets your needs. You could reduce the total cost of investment of your rollover funds to about 1/5 of one percent per year and still get a high quality, well diversified portfolio of institutional quality. It’s not too difficult to see the obvious cost advantage and impact that might have on accumulations down the road.
If creditor protection is a major concern, check your state’s bankruptcy code to make sure that an IRA would be shielded against any potential claims. A qualified plan like a 401(k) enjoys federal exemption from most creditors. But an IRA is not a qualified plan and subject to state code. Some states like Florida offer almost complete protection, while other states offer virtually none. If the assets are significant, or the concern is great, get a legal opinion before you give up Federal Qualified Plan creditor protection.
Trustee to Trustee Transfer
Whatever kind of rollover you decide on, make sure it’s a trustee to trustee transfer where the money never passes through your hands. This avoids any nasty tax problems where you are considered to have received the funds for tax purposes at ordinary income rates with the potential additional 10% penalty tax.
If you don’t feel comfortable managing your rollover, you can hire an investment advisor. Then you should expect advice on asset allocation decisions, consolidation of accounts, tax strategies, withdrawal strategies for retirement distributions, rebalancing, fund selection and monitoring, and estate planning. While this increases cost, you might decide that you are likely to get a better outcome with a professional managing it for you. If that’s your choice, make sure you get a Fee Only Advisor that will assume fiduciary status for the account in writing.