Rollovers From Employer-Sponsored Retirement Plans

A rollover is generally a transfer of assets from a retirement plan maintained by your former employer. Rollovers from an employer-sponsored retirement plan can take one of four forms:

1. A transfer from your old retirement plan directly to an IRA trustee (this is a type of direct rollover)
2. A transfer from your old retirement plan to you, and then, within 60 days, from you to an IRA trustee (this is a type of indirect rollover)
3. A transfer from your old retirement plan directly to the trustee of the retirement plan at a new employer (this is a type of direct rollover)
4. A transfer from your old retirement plan to you, and then from you to the trustee of a retirement plan at a new employer (this is a type of indirect rollover)

Generally, rollovers come from defined contribution plans. A defined contribution plan is a retirement plan in which contributions are based on a set formula (e.g., a percentage of the employee's pretax compensation), while the payout is based on total contributions and investment performance. The 401(k) plan is the most common type of defined contribution plan.

If a rollover is done properly and rules are followed, there will be no taxes or penalties imposed on the retirement plan distribution. In addition, a rollover encourages retirement savings by allowing you to continue tax-deferred growth of the funds in the IRA or new plan. When you are eligible for a rollover from your plan, the plan administrator must send you a timely notice explaining your options, the rollover rules, and related tax issues.

Advantages of Doing a Rollover

A rollover is not a taxable distribution

A properly completed rollover (direct or indirect) is a tax-free transfer of assets, not a taxable distribution. That means that if you complete the rollover within 60 days of receiving the distribution and follow other federal rollover rules, you will not be subject to income tax or early withdrawal penalties on the money. You will not have to pay federal or state income tax on the money until you begin taking taxable distributions from the IRA or new plan. By that time, you may be retired and in a lower income tax bracket. Also, if you are 59 1/2 or older when you take distributions, you will not have to worry about premature distribution penalties.

A rollover allows continued tax-deferred growth

When you do a rollover, you are simply moving your retirement money from one tax-favored savings vehicle to another. This allows the money to continue growing tax deferred in the IRA or new plan, with little or no interruption. Tax-deferred growth allows your retirement money to potentially grow more rapidly than it might outside an IRA or retirement plan. To understand why, consider the power of compounding. As your IRA or plan investments earn money, those earnings compound on top of your principal and any earnings that have already accrued. As this is happening, no tax is due while the funds remain in the IRA or plan. Depending on investment performance, the long-term effect on your savings can be dramatic. In most cases, this benefit is lost if you receive a distribution from your employer's plan and do not roll it over.

A rollover may be an option every time you leave a job

You may be able to roll over your vested benefits in former employer's retirement plan every time you leave a job (whether voluntarily or involuntarily). You generally have the option of rolling over benefits from the old plan to the new plan. There is no limit on the number of rollovers from an employer-sponsored retirement plan you can do, which is an advantage for those who change jobs frequently.

Disadvantages of doing a rollover

You cannot revoke a rollover election

Once you have elected in writing to roll over your retirement plan benefits to an IRA or another plan and received payment, you typically cannot change your mind and revoke the election. If you do try to revoke it, you will generally be subject to income tax and penalties on all or part of the distribution. Before you elect the rollover option, be absolutely certain that this is what you want.

You cannot roll over certain amounts

You generally may not roll over any distribution that is not includible in your taxable income (direct rollovers of after-tax contributions from one qualified plan to another qualified plan and to a traditional IRA are permitted in some cases). Also, you cannot roll over amounts to be taken as required minimum distributions or as substantially equal payments.

An indirect rollover can be costly

If you are considering an  indirect rollover, bear in mind the 20 percent mandatory withholding requirement. To complete the rollover, you must make up the 20 percent out of your own funds, or be subject to income tax and possibly penalties on the shortfall. This can be a problem if you do not have cash available to replace the 20 percent. Also, with an indirect rollover, you generally have only 60 days to complete the rollover. The 60-day period begins with the date on which you receive the distribution from the former employer's retirement plan. If you fail to complete the rollover within this time frame, all or part of the distribution to you will be taxable and perhaps penalized.

Loss of lump sum averaging and capital gain treatment

If you roll over all or part of a distribution from a qualified employer retirement plan into an IRA, neither that distribution, nor any future lump-sum distribution you receive from the qualified plan will be eligible for special 10-year averaging or capital gains treatment.

This information is just a basic overview on rollovers from employer-sponsored retirement plans. For more detailed information or questions, use the contact me link at our website.$

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Fundamental Indexing: A Different Approach

Investors generally can divided into two camps: those who believe the market constantly misprices stocks, leaving opportunities for active traders to take advantage of; and those who accept the "efficient market theory" and believe that it is better to just hold index funds. But this "active versus passive" debate often leaves out a third viewpoint.

That view reflects the belief that while the market is not always perfectly efficient, it is difficult to consistently pick enough "winners" to overcome the management fees, trading expenses and income taxes associated with active stock trading.

Passive investors - meaning those who think that the market's pricing generally reflects the approximate current value of a company, given its future prospects - typically turn to index funds as the vehicle of choice. An index, like he S&P 500 or the Barclays U.S. Aggregate Bond Index, represents that particular small or large part of the market: If the market goes up or down, the index will move in parallel, since it is invested in the same way the market itself is constructed. Index funds are less expensive to operate, as their managers do not have to work to continually beat the market.

That said, most indexes have some disadvantages. Traditional indexes are "market cap weighted" (number of shares outstanding times their stock price). The higher the relative market value of a company, the greater portion of the index it will represent. However, when securities become over- or under-valued, market cap-weighted indices must assign a greater relative share to overvalued stocks; as a result, the market-cap indices exaggerate the market movement. For example, if a tech stock is trading at an excessive price/earnings (PE) ratio, a market-cap index will hold a larger amount of this stock than a similarly-sized company trading at a reasonable PE ratio.

Fundamental indices represent a different approach. Company size is measured by four equally weighted factors: sales, cash flows, book value and dollar value of dividends paid. These four factors are used to generate a ranking of the stocks in the sector being tracked. Note that his method completely ignores stock price, so while the market may be overvaluing that tech company mentioned above, the mispricing has no impact on how the stock ranks in a fundamental index. The fundamental methodology does not completely avoid owning "overvalued" stocks; it just holds them based on a truer measure of their value, not their stock market value. There is a large overlap when comparing the two - the names are most often the same, but the ranking is different.

Not many advisors have made the switch to fundamental indices, and we're glad they haven't. It's one more way that we can create an advantage for our clients. As we continue to scan the horizon for "best practices," we'll bring you what we find, so that there will be more and more ways for you to benefit from working with Retire Village.$

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Retirement: Five Financial Risks Ahead

In retirement, there are five major financial risks that must be accounted for. Your retirement income plan needs to have a solid strategy that helps you address and navigate these risks.

1. Interest Rate Risk. Traditionally, bonds were a great option to provide interest income to help supplement a retirees' Social Security or pension benefits. If a retiree required an extra $40,000 in annual income, and bonds were paying 4%, they would have to purchase $1 million worth of bonds. This would basically be an all-in strategy, where all of a person's savings went into bonds. That was ok when people retired at 65 and lived to age 72. Now, we have potentially 30-year periods in retirement. This leaves the retiree exposed to interest rate risk. Just what is interest rate risk? A fundamental principle of bond investing is that market interest rates and bond prices generally move in opposite directions. When market interest rates rise, prices on fixed-rate bonds fall. Interest rate risk is common to all bonds, even U.S. Treasury bonds. A bond's maturity and coupon rate generally affect how much its price will change as a result of changes in market interest rates. A bond's yield to maturity shows how much an investor's money will earn if the bond is held until it matures. If you have to sell your bonds before maturity, say when interest rates are rising, they may be worth less than you paid for it.
2. Market Risks. Another strategy is a mix of stocks and bonds. Bonds provide interest and stocks would give growth, providing a hedge for inflation. The problem with this drawdown strategy is that the markets have to cooperate. If you start taking income when markets are down, you are really decimating your portfolio. You're exponentially increasing the chances of running out of money in retirement. Stocks and bonds can be down at the same time. Market risk is the possibility for an investor to experience losses due to factors that affect the overall performance of the financial markets. Market risk cannot be eliminated through diversification, though it can be hedged against. The risk that a major natural disaster will cause a decline in the market as a whole is an example of market risk. Other sources of market risk include recessions, political turmoil, changes in interest rates and terrorist attacks.
3. Longevity Risk. Individuals often underestimate longevity risk. In the United States, most retirees do not expect to live past 85, but this is in fact the median conditional life expectancy for men at 65 (half of 65-year old men will live to 85 or older, and more women will). For individuals, insurers provide the majority of products designed to help individuals manage the risk that they outlive their assets. Individuals without defined benefit plans can ensure lifetime income by purchasing annuities within their defined contribution plans and personal retirement accounts.
4. Inflation Risk. Inflation risk, also called purchasing power risk, is the chance that the cash flow from an investment won't be worth as much in the future because of changes in purchasing power due to inflation. Although the record inflation of the 1970s is history, inflation risk is still a common worry for income investors. Inflation causes money to lose value, and any investment that involves cash flows over time is exposed to this inflation risk. The ramifications of this can be serious: The investor earns a lower return than he or she originally expected, in some cases causing the investor to withdraw some of a portfolio's principal if he or she is dependent on it for income. It is important to note that inflation risk isn't the risk that there will be inflation, it is the risk that inflation will be higher than expected.
5. Healthcare Risks. Inflation on healthcare costs coupled with living longer in retirement can spell disaster if not properly managed. Compounding this issue further is the rate of inflation on items such as prescription drugs and preventive care, which have historically exceeded the 3% general rate of inflation. According to a 2011 Fidelity Investments study, a 65-year-old couple would need $230,000 to pay for medical expenses through retirement, not including long-term care costs ranging from $35,000 for assisted living facilities and home health care, all the way up to $70,000 or more for nursing home care. These are significant expenditures which show no sign of decreasing. Traditional solutions such as Medicare and Medicaid are helpful, but they aren't always enough to meet an individuals needs. Around 69% of pre-retirees are very or somewhat concerned about having enough money to afford adequate healthcare; 51% of retirees share that level of concern. Additionally, 63% of pre-retirees are concerned about having enough to pay for long-term care; 52% of retirees share that concern.

If you are nearing retirement, or are already there, you need a strategy that addresses ALL of these risks. Professional mountain climbers know that most fatalities and injuries happen on the way down the mountain, not during the climb. Likewise, you have successfully navigated your way to the retirement savings summit. Now, you need a way to safely de-cumulate. There are a lot of risks to staying retired. If your current advisor is not helping you address all, or at least most of these risks, it's time for a second opinion.$

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