The Markets November 8, 2019

The Pros and Cons of Rolling Money Over to an IRA

Experts see more value for participants to move their money from one 401(k) to another 401(k) than from a 401(k) to an individual retirement account.

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As to the question of whether a participant leaving an employer is better suited to move their money into their new employer’s retirement plan or an individual retirement account (IRA), the experts see more value in the former.

However, there are some pluses to moving into an IRA. Should participants roll their money over to an IRA, they will be able to invest in any type of instrument, notes Steve Bogner, managing director and partner at Treasury Partners. Another benefit of an IRA is that, should the account holder die, their beneficiaries will have the option to take the distributions over their lifetimes, which is known as a “stretch IRA,” says Larry Steinberg, chief investment officer at Financial Architects Inc. By comparison, beneficiaries of the money from a 401(k) must take the money within five years, he says.

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Besides these two benefits, however, the experts say there are a number of drawbacks to moving the money into an IRA that sponsors might want to make their participants aware of—first and foremost of which is the retail versus institutional fees that participants will pay, notes Ric Edelman, co-founder and chairman of financial education and client experience at Edelman Financial Services.

IRAs also do not have the protections of qualified plans, which are overseen by the Employee Retirement Income Security Act (ERISA), requiring sponsors to act in the best interest of their participants, Steinberg says.

In addition, IRA contribution limits are $5,500 a year, whereas 401(k)s permit contributions of $19,000 a year, says Brett Tharp, CFP senior financial planning analyst at eMoney Advisor. Yet another drawback with IRAs is that creditors to lay claim to that money, whereas it is very difficult for that to happen in an ERISA 401(k) plan, Steinberg says.

Client Service November 8, 2019

Ways to Combat Leakage

The Savings Preservation Working Group says that at least 33% and as many as 47% of plan participants withdraw part or all of their retirement savings when switching jobs.

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While most retirement plan advisers and sponsors focus on ways to inspire participants to save more, on the flip side, leakage from retirement plans is a serious issue they also need to address.

According to a report from the Savings Preservation Working Group, “Cashing Out: The Systemic Impact of Withdrawing Savings Before Retirement,” which analyzed a variety of recent research and data, cash-outs from plans when people switch jobs are the most prolific form of leakage. This surpasses hardship withdrawals by eight-times and loan defaults by 130-times.

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The Working Group found that at least 33% and as many as 47% of plan participants withdraw part or all of their retirement savings when switching jobs. This leakage runs between $60 billion and $105 billion a year.

The first thing advisers and sponsors need to do to help prevent leakage is to educate participants about the downsides of cashing out, taking out a loan that they might not repay in full, or resorting to a hardship withdrawal, says Mike Lynch, vice president, strategic markets, at Hartford Funds.

Participants need to know that cashing out of their retirement plan could jeopardize their retirement security, says Ric Edelman, co-founder and chairman of financial education and client experience at Edelman Financial Services. Participants also need to know they will have to pay ordinary taxes on the money and, if they are under the age of 59 ½, the IRS will charge them a 10% penalty, Edelman says.

“From a retirement planning perspective, this is the worst choice that they can make,” he says.

Furthermore, if a participant cashes out and immediately spends all or most of the money, they may not have adequate cash on hand to pay the upcoming taxes, warns Larry Steinberg, chief investment officer at Financial Architects, Inc.

When a participant cashes out of a plan, investment firms are required to withhold 20% of their balance in order to cover taxes, but this is just an estimate, Steinberg says. “In California, you can owe as much as 53% of a distribution, because that is the marginal federal and state tax rate for someone in the top tax bracket,” he says.

To prevent participants from taking out loans or hardship withdrawals or cashing out, employers can consider setting up automatic emergency savings accounts for them, says Mike Webb, vice president at Cammack Retirement. While these are offered by only a handful of employers, Webb is hopeful they will gain traction.

Another thing employers can do to get in front of leakage is to offer additional benefits that employees can tap into, says Tom Foster, national spokesperson for MassMutual’s workplace solutions unit. “This could include health savings accounts, 529 college savings plans, student loan programs, critical illness insurance, accident insurance, life insurance, and access to low-cost loans,” Foster says. “Sponsors can offer many alternatives, and it doesn’t cost them additional money.”

Advisers can play a critical role in this effort by “explaining to sponsors that it would be a disadvantage to them if they don’t have the right benefits to attract and retain employees,” he says.

Another thing that advisers and sponsors can do is to “offer financial wellness programs and seminars and tutorials on the basics of budgeting and setting up an emergency fund,” Foster says. And if the sponsor has decided to offer additional benefits, this is an opportunity for advisers to educate them about these various options and to help participants prioritize their dollars into these benefits, he says.

“And if the employer doesn’t offer these additional benefits, advisers can work with employees to see what financial resources they might have other than their 401(k)—be it other savings, insurance or help from relatives,” Foster says.

Foster reminds advisers and sponsors that providers have many educational tools and calculators that they can use in their efforts to combat leakage.

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