Given the current economic environment where companies are laying off workers and, in some cases, going out of the business, the implications for employer-sponsored retirement plans are significant.
Unfortunately, one of the consequences of the pandemic and the economic shutdown is that many companies are laying off workers and, in some cases, shutting down completely. It is important to note that company retirement plans are not assets of the company – therefore, no matter the fate of your employer, your vested balance belongs to you as the account holder and cannot be accessed by the company or its creditors.
If you lost your job or if your company closed, you have some options as to what you can do with your retirement plan. You have the option to (1) distribute your account; (2) rollover the account to an IRA or (3) keep the account as is in the company plan (so long as the plan is not terminated).
- If you choose to distribute your account, you will need to declare the entire distribution as income, and it will be subject to ordinary income tax. All future tax-deferral is lost. This is rarely a good option, even if you need immediate access to some of the funds. The CARES Act provides relief for coronavirus related distributions – this should be considered prior to making a choice to distribute the entire account. See link to CARES Act: IRA and Retirement Plan Provisions.
- If you rollover the funds into an IRA, the funds remain tax-deferred and there are no immediate tax implications. You can then invest the funds as you choose instead of being limited to the options available within your plan.
When determining which course of action is most prudent, here are some considerations to keep in mind.
Costs – There is a significant range in the cost of retirement plans to participants. There are administrative costs as well as the costs associated with the investments. The higher costs, the more compelling to consider a rollover. As a general rule, simply due to scale, smaller plans tend to be more costly.
Investment Choices – Investors want solid, low-cost, well-diversified investment options. If your plan does not offer this, a rollover provides an attractive alternative.
Other Retirement Assets – Today it is common for people to work for several employers over their careers. That means that it is possible to have multiple 401k plans. To simplify and promote ease of management, consolidation of these accounts in an IRA is recommended. Additionally, as time passes from your termination date, it can be more challenging to facilitate a rollover as in some cases, you may need to get in touch with your former employer for paperwork and signatures.
Management – If you choose, an IRA can be professionally managed in conjunction with your other investment assets and within the framework of your overall financial plan. We recommend working with a fee-only advisor who utilizes low-cost, well-diversified mutual funds to achieve targeted exposures and to guide you in developing a flexible plan that can be modified as necessary based on your circumstances.
Credit Protection – In the state of Florida, both IRAs and company retirement plans are protected from the claims of creditors.
Loans – IRAs do not permit loans. If you have an outstanding loan in your 401k plan, you will want to be sure to pay it off prior to doing a rollover; otherwise, the loan will be considered a distribution and it will be subject to income tax. Even if your company does offer 401k loans, they typically will not allow you to borrow additional funds once you are no longer employed.
A rollover from a retirement plan to an IRA can be accomplished through either a Direct or an Indirect Rollover. A Direct Rollover is preferred.
Direct Rollover – The funds in the 401k are transferred directly from the 401k plan to the IRA custodian. In most cases, the 401k investments are sold, and a check is issued to the custodian for the benefit of the account holder. Once the funds are deposited into the IRA, the account holder can then invest the funds however they choose. There is no limit on how many direct rollovers an account holder can do in any given year.
Indirect Rollover – The 401k investments are sold, and a check is issued to the account holder. The account holder then has 60 days to deposit the funds into an IRA to maintain the tax-deferred status of the funds. If the funds are not deposited into an IRA within that time-frame, it is considered a distribution and is subject to income tax. 401k custodians are required to withhold 20% for income taxes on indirect rollovers. Therefore, the account holder will need to make up for that 20% withholding from other funds to deposit into the IRA. Additionally, account holders can only do one indirect rollover per 365- day period.
When doing a rollover, it is important to remember that in most cases, your investments will be sold so that a check can be issued. This would mean that you may be out of the market for a period of time (from when the investment is sold until the check is deposited into the IRA). Additionally, you won’t necessarily have control as to when the investments are sold. Given the heightened volatility in the market over the last several months, this is something to keep in mind and plan for. One option would be to adjust your allocation to all cash when you choose and then immediately request the rollover – in that way, you can control what day you get out of the market. This is not to advocate timing the market, but it would enable you to be sure that you are not selling on a day when the market experienced a significant drop.
The financial challenges presented by the COVID-19 pandemic are numerous. This is true no matter whether you are new to the workforce, you are in your peak earning years or you are retired or soon to be retired. Being proactive and making good choices regarding your cash flow planning, your investment program and your retirement are of paramount importance. And that is where working with a financial planner can prove so valuable.