How to Consolidate Your Retirement Accounts

This week, Gail discusses ways to roll over 401(k) assets in order to consolidate your retirement money, and explains the tax implications of 529 college savings plans.



I have a 401(k) with my former employer, another 401(k) with my current employer, and a traditional (non-Roth) IRA. To simplify my recordkeeping, I'd like to roll the 401(k) with my former employer over into one of the other accounts.

Which one, if any, would be better, and why? If it matters, the old 401(k) and the IRA are managed by the same investment company.



Dear Phil,

You're on the right track in trying to consolidate your retirement accounts. It's a lot easier to monitor your investments and adhere to your desired asset allocation when your money isn't spread around a bunch of different plans.

While it has always been possible to roll 401(k) assets from one plan to another, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) passed last year has made it possible for other types of retirment plans to do this, too. For instance, someone working for a government entity who is covered by a 457 plan can now roll the balance in their account into any other type of retirement plan, including an IRA.

The ability to move retirement money from one plan to another is referred to as "portability." However, as I've written before, just because the government allows this to happen, it doesn't mean you'll actually be able to do it. Huh?!

You see, Phil, in order for you to transfer the money sitting in your old 401(k) into your current plan, the legal document which governs your current plan must permit it. If, for some reason, your employer has chosen to not allow this, then this isn't even an option for you.

However, if your current 401(k) does accept rollovers from other plans, you need to be aware that the money you transfer in will be subect to all of the privileges and restrictions your current 401(k) imposes. This would include the ability to take a loan from your account and possible limitations on how your money must be distributed when you retire.

The one account that always accepts retirement money from other plans is your IRA. For most people, this is usually the best option. An IRA is simply much more flexible than a qualified plan. Take the issue of who you name as your beneficiary. With a 401(k), if you are married your MUST name your spouse as your beneficiary. If you want to name someone else, you need to obtain written permission from your spouse.

IRAs also give you more control over how you invest your retirement money. Instead of being limited to the choices in your employer's plan, you can often choose among more than 7,000 mutual funds, individual stocks and bonds and even certain gold coins.

If you die with money left in your 401(k), your heirs generally have to empty your account within 1-5 years. This isn't a big problem if your spouse is your beneficiary because she/he can always roll the 401(k) balance into an IRA of their own. But it's a disaster for anyone else. Since a non-spouse beneficiary doesn't have the option of rolling over the money, they have only one choice: withdraw it within the allotted time, pay a hefty income tax bill and lose any further tax-deferred growth.

On the other hand, if you die with money left in an IRA, anyone who inherits your account can leave the money under the protective shelter of an IRA, allowing them to control taxes (due only when withdrawals are taken) and extend the potential for the investments to continue to grow on a tax-deferred basis.

There are a couple of disadvantages to an IRA: unlike a 401(k), the age at which you can access your money without a 10% early withdrawal penalty is 59 1/2 -- not age 55. You cannot take a loan from your IRA. And, depending upon the state where you live, IRAs might not have the same level of creditor protection.

But if you don't think you're going to need to tap into your IRA early and don't expect to file for bankrupcy, in my opinion, an IRA is the superior choice -- for both you and your beneficiaries.

Best wishes,




I have not been able to find if contributions to a 529 plan are federally tax-deductible and can a grandparent receive the deduction if the grandparent makes the contribution?




Dear Wayne -

You cannot take a tax deduction on your federal income tax return for contributions made to a 529 college savings plan. The tax benefit on 529s comes at the end instead of the beginning: when you take withdrawals there is no federal income tax on the gains the account has earned provided the money is used for "qualified" higher education expenses such as tuition, room & board, books, fees and supplies.

Some states allow their own residents to take a tax deduction for contributions made to the 529 plan sponsored by that state. While this sounds great, it is usually worth less than you think unless you live in a state with a high income tax rate. And every state sets a limit on the maximum deduction you can take each year.

For instance, assume you live in the state of Michigan, with an income tax rate of 4.2%. As grandparents, you make a $4,000 contribution to Michigan's 529 plan on behalf of your grandchild (who could live in another state). As Michigan residents, you can deduct your contribution from the amount of income you pay state income tax on, saving $168 ($4,000 x 4.2%).

However, this is not your "total" tax savings.

As you know, when you calculate your federal taxable income, the IRS allows you to subtract any state taxes you paid. Since you paid $168 less in state income tax, this means the income you report on your federal tax return will be $168 higher.

If you're in the 30% federal tax bracket, this means you will pay $50.40 more in federal taxes ($168 x 30%). So your total or "net" tax savings is $117.60 -- not $168. By getting a tax deduction on the state level, you end up paying more federal income tax.

If, you chose to use a 529 plan offered by another state, you would not get the tax deduction from Michigan. However, if the investments in the out-of-state plan outperformed those in the Michigan plan, you have the potential to come out ahead in the long run. The more years you've got before the child will need to start withdrawals, the more important investment performance becomes.

No college savings plan gives you a tax deduction on your federal return, including the Coverdell Education Savings Account (a.k.a. the "Education IRA"). Regardless, as I've said here before, in my opinion 529 plans are the smartest way to save for a child's college education.

Go for it!



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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.