By Peter Schumacher, CPA, SVP Wealth Advisor, Johnson Financial Group
This article is part of a continuing series of articles about retirement planning.
Among the decisions you must make if you change employers or leave your job is how to handle your 401(k) account. Oftentimes, employees face decisions about their 401(k) plans through no action of their own. When companies are bought, sold or merged, existing 401(k) plans may be terminated and replaced by new ones.
Under either scenario—if your company's plan is terminated or you separate from your employer—the simplest choices might appear to be to roll your assets into the 401(k) plan at your next employer or to take a lump sum. But rolling the money into an IRA can be a much more advantageous strategy, especially when considered as part of your estate planning.
Although some 401(k) plans offer a good number of diverse investment choices, others are more limited. With a self‐directed IRA, you can put your money into a much wider universe of investment options. And, if you change jobs multiple times throughout your career, rolling your 401(k) assets into your IRA is a simple resolution to consolidate those investments when your employment changes.
When done properly, a rollover will not incur income tax or penalty and your account will remain tax‐deferred. Some of the advantages of rolling over into an IRA include:
Self‐directed IRAs can act as estate planning tools that may be useful compared to 401(k) plans. Proper beneficiary planning on an IRA will allow for both spousal and non‐spousal beneficiaries to continue the tax deferral of your account even after your death. This is often referred to as the “stretch” strategy and it can be used with both traditional and Roth IRAs. For more information, read this earlier post.
Most investors name a spouse as primary beneficiary on their IRAs, but with proper planning, the IRA assets can continue to grow tax‐deferred to benefit children and succeeding generations. This stretch or multi‐generational strategy works best if you don't think you will need all of your IRA assets during your retirement.
Under this strategy, after the investor's death, the IRA assets become the spouse's assets. The spouse can perform a tax‐free rollover into his or her own IRA and then name children as beneficiaries. The IRA's required minimum distribution (RMD) calculation switches from the original investor's life expectancy to the spouse's.
After the spouse's death, the assets can be inherited by the children, who might be able to take lesser RMDs, using their own life expectancies. That allows the IRA assets to continue to grow tax‐deferred, and the children, in turn, can designate their own children as beneficiaries. Beneficiaries also would have the option of taking a lump sum distribution instead of continuing the IRA account, but that would be subject to income tax.
It's important to note that a spouse is the only beneficiary who can commingle inherited IRA assets with an existing IRA and can continue to contribute to it. Non‐spousal beneficiaries can't co‐mingle inherited IRA assets and they can't add money to an inherited account.
Here are some key steps we encourage our clients to take to establish a multi‐generational IRA:
Johnson Financial Group and its subsidiaries do not provide tax advice. Please consult your tax advisor with respect to your personal situation. Wealth management services are provided through Johnson Bank and Johnson Wealth Inc., Johnson Financial Group companies. Additional information about Johnson Wealth Inc., a registered investment adviser, and its investment adviser representatives is available at https://www.adviserinfo.sec.gov/. NOT FDIC INSURED | NO BANK GUARANTEE | MAY LOSE VALUE