According to the Pew Research Group, the number of retired Baby Boomers had been growing annually since 2011 at a rate of about 2 million on average, but in 2020 that number jumped to 3.2 million. These retirements may have been long planned, or the pandemic-related new work dynamics may have encouraged an early exit. Retirement is a declaration of financial independence, an emotional step. Happily, the tax preferred status of retirement funds doesn’t need to disappear just because you aren’t working.

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One of the most popular retirement savings accounts is the IRA (Individual Retirement Account).

The Investment Company Institute reported that in mid-2020, 37% of US Households had assets in IRAs. This huge number of US households represents trillions of dollars and the largest category of retirement assets held. Some may wonder how IRAs could have become so large given the relatively low contribution limits (currently $6,000 for 2021, or $7,000 for those over 50). The answer lies in IRA rollovers.

The ICI also reported that about 6 in 10 traditional IRA–owning households indicated that their IRAs contained rollovers from employer-sponsored retirement plans. The top four reasons for a rollover were:

  • not wanting to leave assets behind at the former employer
  • wanting to preserve the tax treatment of the savings
  • wanting to consolidate assets
  • accessing more investment options.

I want to rollover the funds to an IRA. How should I do so?

If you do plan to rollover assets into an IRA, there are multiple ways to go about it. The first option is to cash out and cash in, but that could have potential tax complications. If you receive a distribution from your company plan, you have 60 days to roll it over to an IRA. If you miss the deadline, the distribution becomes taxable, and if you are under age 59 1/2, you’ll be hit with a 10% penalty. The same 60-day rule applies if you choose to move money from one IRA to another. There can be exceptions to this rule, but it may be better to avoid handling the cash altogether.  A better alternative is to arrange for a direct or trustee-to-trustee transfer. The funds will move from your plan account to an IRA (or from IRA to IRA) without you touching the distribution yourself.

Additional benefit – When it comes to your company plan, there’s another good reason for a direct transfer to an IRA: no withholding tax. Your employer must withhold 20% of your distribution for taxes, but this withholding is not necessary when the IRA trustee receives the money directly.

A word of caution – If your plan contains employer stock, you have the potential benefit of capital gains treatment of appreciation of that stock. That benefit is lost if you roll the stock over to an IRA. See your tax advisor if you are in this situation.

Tax-preferred status can’t last forever, right?

Although there is a term for “full retirement” or “normal retirement”, there is no best or normal time to retire. The term is a reference to Social Security benefits, which will be decreased or increased based on when an individual starts receiving them. Social Security benefits could be started as early as 62 years of age, or as late as 70 years of age.

Many may be transitioning to retirement prior to that age, or continuing to work after that age. There are some age-related restrictions for other retirement accounts too. If money is taken out of a traditional 401(k) or traditional IRA prior to being 59 ½, there is a 10% tax penalty imposed on it. These accounts can’t be held with their tax preferred status forever either. The age for beginning to end the tax benefit was raised from 70 ½ to 72 by the SECURE Act, passed in December 2019.

Failure to take a required minimum distribution (RMD) carries a heavy penalty – the IRS states “if an account owner fails to withdraw a RMD, fails to withdraw the full amount of the RMD, or fails to withdraw the RMD by the applicable deadline, the amount not withdrawn is taxed at 50%”. The RMD is based on life expectancy and the size of the account, so it changes each year. However, it’s possible that a traditional IRA owner would take RMDs and still have an active account in his 90s or even beyond that. Starting to take distributions doesn’t mean losing the preferred status of the account right away.

Even better – if an individual has a Roth IRA, then RMDs will not be required during life. If an individual has both account types, he or she can leave the Roth alone while taking funds from the Traditional IRA to stretch the tax-preferred status. Eventually even that tax-preferred status will be lost though, as even if the funds aren’t depleted the during the owner’s life the inherited Roth IRA will be subject to required distributions.

Thinking of retirement? Perhaps partial retirement or a work optional lifestyle?

Meeting with a client advisor, such as those at Arvest Wealth Management, can help illuminate the costs that might come up and paint your whole financial picture so you can understand whether you’re financially ready to take the leap. Once you are, they will be excited to celebrate with you, and transfer assets into new accounts as appropriate.

Arvest Wealth Management does not offer tax or legal advice – consult a professional. This content has been provided by Merrill Anderson and is intended to serve as a general guideline.


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