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Consolidating Defined Benefit Plans

William J. (Bill) Lynott |

CHICAGO — The more things change, the more they stay the same. So goes that old saying illustrating an important truth in many aspects of life, but not in retirement planning.

The world of retirement planning has undergone many drastic changes in recent years, most of which would appear to be here to stay. Perhaps the most significant of those is the gradual disappearance of the corporate defined benefit plan.

A generation ago, in the days of generous corporate retirement plans, spending an entire working career with one employer was a common experience; these days, not so much. Today, many if not most of us will have more than one employer during our working careers.

Some of those employers may provide one of the new retirement accounts such as 401(k)s and some may not. In those cases, we have the option of opening individual retirement accounts (IRAs) to help save money for our retirement years. As a result, over a working career, many people wind up with retirement dollars spread out in several different accounts.

Accumulating multiple IRAs and 401(k)s is not the best investment strategy, according to Nancy Skeans, CPA and Certified Financial Planner, Schneider Downs Wealth Management Advisors, Pittsburgh. “This can be counterproductive to a good investment strategy for several reasons,” she says. “Some examples are: (1) one account is so small, we just ignore it or let it sit in cash earning little or no investment return, (2) due to mutual fund investment minimums, our smaller dollar amounts may end up in funds that charge higher management fees, or (3) we end up collecting mutual funds over time with no real investment strategy in mind.”

Consolidating IRAs and 401(k)s into a single IRA can help to solve these problems, according to Skeans.

“First, when added all together, the higher dollar amount might now get your attention. Second, the higher balance may allow you to invest in a mutual fund or a lower-cost share class of a particular fund that was not available before. Third, when all of the assets are in one account, you will be better able to build and monitor a diversified portfolio with a common investment strategy,” she says.

“However, before you start closing IRA accounts or requesting distributions from old 401(k) plans, you should be aware of the tax implications and penalties that can be assessed if the consolidation is not handled correctly.”

Skeans suggests picking a single IRA account into which all of the other accounts are going to be rolled.

“Most important, don’t request that any distributions from the old accounts be paid to you personally,” she cautions. “Have all distributions sent directly for your benefit to the custodian of the common IRA that you have selected. This is called a trustee-to-trustee transfer.”

The mistake you want to avoid is closing one retirement account and requesting payment to you directly. If you do that, the custodian is required to withhold income taxes.

When you receive the check to roll over, the taxes have to be made up. For example, if you are 40 years old and withdraw $10,000 from a regular IRA, the custodian will give you a check for $8,000 ($2,000 must be withheld for income taxes). Now, if you do not put $10,000 into another IRA within 60 days, you will have to report the $10,000 on your tax return, pay income tax on it, and pay a 10% penalty for early withdrawal.

If you instead roll over the $8,000 you received within 60 days, you still have to report the $2,000 of income and pay tax plus a penalty of $200. This is also true if you take the money from an old-employer 401(k). (The IRS allows 60 days to move money from one retirement account to another without penalty or income taxes.)

“All of this is avoided by using a trustee-to-trustee transfer,” says Skeans. “Since you never touch the money, there is no requirement for the old custodian to withhold taxes. If you are moving money from a 401(k), you have the custodian of the 401(k) transfer the assets directly to the custodian of your IRA. That way, no taxes are withheld, and there are no early withdrawal penalties. It takes a bit of extra work, but in the long run, it ensures that no mistakes are made, and taxes and penalties are avoided.”

It’s a good idea, Skeans suggests, to have a financial planner help you with setting up trustee-to-trustee transfers and other investment planning. However, brokerage firms such as Charles Schwab, Vanguard, Fidelity and most others have departments that work with setting up and transferring retirement assets for individuals.

“They can explain the process thoroughly and help with the paperwork,” says Skeans.

Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult an accountant or tax adviser for advice regarding your particular situation.

About the author

William J. (Bill) Lynott

Freelance Writer

William J. (Bill) Lynott is a freelance writer whose work appears regularly in leading trade publications and newspapers, as well as consumer magazines including Reader’s Digest and Family Circle. You can reach Lynott at blynott@comcast.net.

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