Employee Benefit
Retirement and Distribution Planning
Employee
benefit retirement and distribution
planning is in regards to Qualified Retirement Plans such as 401k or
403b, 457, Roth 401k, Roth 403b, and how they
interact
with IRA's.
It is easy to
get into a tax trap with these. For example, if you borrow from a 401k
you must pay your account interest which is usually not tax deductible,
yet when you retire and get a distribution then you are taxed on the
interest that you paid to yourself. Thus 401k's used improperly can
create a tax trap. Also, using a 401k loan stops you from contributing,
thus your true cost of a 401k loan would include loss of the company
match and loss of the use of a safe haven to have long term tax
deferral. There are tax rules that restrict above average earners from
contributing to an IRA if they also are deemed to be a participant in a
401k, even though it may appear they are not a participant, there are
subtle reasons that one can be "deemed" by IRS to be a participant.
Another tax surprise is that the highest paid employees are not allowed
to contribute the full amount of the 401k contribution amount if the
low income employees fail to participate in the 401k.
Special rules apply for 403b participants
with over 15 years on the job or for 403 participants who have a
pre-1987 balanced and who seek to defer RMD's until age 75. Careful
financial planning needs to be done to integrate the client's needs for
liquidity kept outside of a Qualified retirement account (for emergency
spending, etc.) while still following a goal of building up a
tax-deferred retirement account. Employee
benefit retirement and distribution
planning needs to examine this issue.
For clients with a
significant net
worth, it may be a mistake to build up a 401k or IRA because the
combination of estate tax and income tax on those is about 75%. If you
are
retired and have a net worth large enough to be concerned with estate
tax then you may not want your heirs to inherit an IRA or a 401k;
instead you may want to explore charitable giving or simply spend down
the proceeds while you are alive so that your estate will pay less
estate tax. This is an example of how financial planning including Employee
benefit retirement and distribution
planning must
be custom
tailored for each client and the various topics of financial planning
must be integrated with each other.
401k qualified retirement plans can be
rolled over to an IRA when
someone changes jobs or retires. In some cases employers permit a 401k
to be rolled over to an IRA while you are still employed with that
employer. That is called an "in-service distribution". Generally
speaking
it is better to rollover a 401k to an IRA because you have more freedom
to invest and you have more control and better service in terms of
estate planning details. Also, if you keep several 401k's this can get
confusing because each employer has different rules and different
investment choices. Employee benefit retirement and
distribution
planning should take this matter into account.
However, there are reasons to
keep a 401k. You
can borrow from a 401k, but not from an IRA. 401k plans at large
employers can sometimes access low cost "I" class mutual funds that are
not available to retail consumers. If you terminate employment after
the year you turn age 55 you can get a distribution (not a loan) from a
401k with no early withdrawal penalty, but for IRA's you must wait till
age 59.5 to make a withdrawal that is free of penalty.
So if you will turn 55 in December, 2010, and if
your employment ends in
January,
2010, when
you are 54.1 years old, then 401k distributions
(withdrawals) are penalty free. This is a rather attractive employee
benefit feature. Of course, you still pay the regular income tax. 401K
rollovers can not be reversed back out of an IRA and into the 401k,
unless someone becomes re-employed at their old job, and not all
employers allow rolling of an IRA into a 401k. This means you should
get careful tax planning and retirement planning to see what is the
best strategy. Tax and retirement planning needs to be integrated with
investment planning. For example, the investments in the 401k need to
be coordinated with those in the IRA and in the taxable account, plus
cash flow needs for retirement need to be planned for and cash for
emergencies need to be set aside.
Whenever you transfer money from a 401k to an IRA or
vice versa always tell the Custodian to do a "Custodian-to-Custodian"
transfer. It is best to do this using the same Custodian for both the
old and new account. Once the funds have been rolled into an IRA then
later you can do another Custodian to Custodian transfer to another IRA
Custodian if you don't like the first one. Also. tell the old Custodian
to be sure to structure the transfer
as one that will have no tax withholding. Make sure the new Custodian
puts the funds into a tax qualified retirement account such as an IRA
or 401k.
Beware of a tax trap: when rolling a 401k to an IRA,
before doing so check to see if you have an Net Unrealized Appreciation
(NUA). Special rules apply that, if not followed, create an
irreversible tax trap. This is why it is important to get integrated
financial planning, including employee
benefit retirement and distribution
planning.
If you have
employee stock options please read that page.
Mayflower Capital
Donald
Martin, CFP®
1000 Fremont Ave.
Ste.
135
Los
Altos,
CA 94024
(650) 949-0775
Don@mayflowercapital.com
Office
hours by appointment
Donald
Martin is a Napfa
registered fee-only financial planner and investment advisor.
