IRA Management, Part I

This isn't your father's retirement plan! No, tax law and company culture changes have shifted the responsibility for managing retirement accounts from the company's shoulders to that of the employee. And judging by the size of the IRA accounts we see, the employees are doing a pretty good managing job!

It's the very size of IRA accounts that raises planning problems, however. Where Dad's IRA might have been for a few thousand, today it's not uncommon for his children to have IRAs in 6 or 7 figures.

The problems these larger IRAs pose are three-fold: (1) Managing the assets pre-retirement, (2) managing the assets after retirement, including dealing with complex required minimum distribution rules, and (3) deciding what to do with an IRA for estate planning purposes. This and my following column will speak to these issues.

Prior to retirement, the obvious objective is to manage the account to maximize growth and protect the principle. It is important not to trigger unintended taxation of the account. For example, it is not uncommon for an employee to change jobs every few years, each time leaving behind an orphan 401(k) plan. These orphaned plans should be consolidated into one IRA account through a trustee-to-custodian transfer.

Such a transfer will be considered a qualified rollover and not require mandatory withholding of 20% of the amount transferred-as would be the case if the employee withdrew the funds directly and then opened a new IRA account to accept the transfer.

Moreover, if an employee under age 55 attempts the do-it-yourself route and hangs on to the money more than 60 days, the rollover is disqualified and the owner will pay income taxes plus a 10% excise tax penalty for a premature withdrawal.

While you cannot borrow from an IRA as you can from many employer-sponsored retirement plans, you are allowed to roll the money over (take it out of the account and use it as you desire) for 60 days each year. Once per year per owner-but be sure it's back not later than the 60th day!

By consolidating IRAs, the owner gains the advantage of ease of management. If set up in a brokerage account, then stocks, bonds, CDs, mutual funds, etc., may be combined in the IRA and the owner will see the entire account on one periodic statement.

Company stock inside company-sponsored retirement plans presents special planning opportunities for the terminating employee. The stock may be distributed from the employer plan to the terminated employee. The tax cost for the distribution is equal to the plan's investment basis in the stock. The gain, equal to the current value at time of distribution minus the plan's basis, is not taxed to the employee at distribution. When the employee sells the stock, the gain is then taxed as a capital gain.

For example, let's assume a terminating employee is the owner of a $1,000,000 profit sharing / 401(k) plan. Inside the plan is $300,000 of employer stock, purchased for the plan at a cost of $50,000. The employee can roll over the $700,000 of other plan assets to an IRA. Then she can request distribution of $300,000 worth of company stock and pay taxes on only $50,000. That distribution is not subject to the 10% premature withdrawal penalty, nor is the employee required to sell the stock as part of a required minimum distribution.

Next time we'll take a look at IRAs as a 'junk money' problem for larger estates, and the problems arising from required minimum distribution rules.

IRA Management, Part I

by Wendell Cayton

June 9, 2000

This isn't your father's retirement plan! No, tax law and company culture changes have shifted the responsibility for managing retirement accounts from the company's shoulders to that of the employee. And judging by the size of the IRA accounts we see, the employees are doing a pretty good managing job!

It's the very size of IRA accounts that raises planning problems, however. Where Dad's IRA might have been for a few thousand, today it's not uncommon for his children to have IRAs in 6 or 7 figures.

The problems these larger IRAs pose are three-fold: (1) Managing the assets pre-retirement, (2) managing the assets after retirement, including dealing with complex required minimum distribution rules, and (3) deciding what to do with an IRA for estate planning purposes. This and my following column will speak to these issues.

Prior to retirement, the obvious objective is to manage the account to maximize growth and protect the principle. It is important not to trigger unintended taxation of the account. For example, it is not uncommon for an employee to change jobs every few years, each time leaving behind an orphan 401(k) plan. These orphaned plans should be consolidated into one IRA account through a trustee-to-custodian transfer.

Such a transfer will be considered a qualified rollover and not require mandatory withholding of 20% of the amount transferred-as would be the case if the employee withdrew the funds directly and then opened a new IRA account to accept the transfer.

Moreover, if an employee under age 55 attempts the do-it-yourself route and hangs on to the money more than 60 days, the rollover is disqualified and the owner will pay income taxes plus a 10% excise tax penalty for a premature withdrawal.

While you cannot borrow from an IRA as you can from many employer-sponsored retirement plans, you are allowed to roll the money over (take it out of the account and use it as you desire) for 60 days each year. Once per year per owner-but be sure it's back not later than the 60th day!

By consolidating IRAs, the owner gains the advantage of ease of management. If set up in a brokerage account, then stocks, bonds, CDs, mutual funds, etc., may be combined in the IRA and the owner will see the entire account on one periodic statement.

Company stock inside company-sponsored retirement plans presents special planning opportunities for the terminating employee. The stock may be distributed from the employer plan to the terminated employee. The tax cost for the distribution is equal to the plan's investment basis in the stock. The gain, equal to the current value at time of distribution minus the plan's basis, is not taxed to the employee at distribution. When the employee sells the stock, the gain is then taxed as a capital gain.

For example, let's assume a terminating employee is the owner of a $1,000,000 profit sharing / 401(k) plan. Inside the plan is $300,000 of employer stock, purchased for the plan at a cost of $50,000. The employee can roll over the $700,000 of other plan assets to an IRA. Then she can request distribution of $300,000 worth of company stock and pay taxes on only $50,000. That distribution is not subject to the 10% premature withdrawal penalty, nor is the employee required to sell the stock as part of a required minimum distribution.

Next time we'll take a look at IRAs as a 'junk money' problem for larger estates, and the problems arising from required minimum distribution rules.

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