Premature Rollovers

Recent studies indicate that more than half of participants spend at least some of their retirement savings well before that date.

An updated report issued by the Congressional Research Service (CRS) reported that almost half (44%) of participants who had received lump-sum distributions from their retirement plans had rolled over the entire amount of their most recent distribution into an IRA or other retirement plan, and another 40% said that they had saved at least part of the distribution in some other way, though that included paying off debts or making home improvements.

Similarly, a recent Hewitt Associates survey of nearly 200,000 plan participants found that 45% took a cash distribution upon their departure, while 32% stayed in the plan, and less than a quarter (23%) rolled over into another qualified plan or an IRA.

Age, Tenure Linked

The Hewitt data found a direct correlation between the age and tenure of employees and their decisions to cash out of their 401(k) plans. The highest incidence of cash distributions was among young employees (66%) age 20 to 29 but, even among those age 40 to 49, 42% elected to cash out of their 401(k) plans upon leaving their jobs.

For advisers, this is an issue that requires significant education. Many people are treating their retirement account distributions like any other savings account, which is detrimental based not only on the loss of savings, but on the tax consequences as well.

Four considerations that any participant education program should focus on are:

• The size of the distribution. The larger the account, the more options the participant has in determining where to move the money or leave the money, and the more significant the penalties will be.
• The participant’s financial status and age. Both criteria will help the participant decide whether to cope with paying the taxes or wait until the can access the money without penalty.
• What types of taxes will be collected. Regular income taxes will need to be paid on employer contributions, pretax contributions, and earnings. Additionally, if younger than 59  the participant will have to pay an additional 10% penalty.
• What does the current plan allow? With EGTRRA requiring balances between $1,000 and $5,000 to be rolled into an IRA by the plan if the participant does not direct, the participant should be aware of what will happen to his savings if he terminates and does not direct his account. Participants should also know whether or not the plan allows them to leave the money in their employers’ plan and be educated about the fact that some plans allow for you to roll money into them.

Discussing rollovers will continue to remain a vital issue for plan advisers as the 401(k) only continues to become the most important savings tool for retirement.

PQ: “The highest incidence of cash distributions was among young employees (66%) age 20 to 29