Dear Readers,
This week's column discusses the pros and cons of moving retirement plans for people who work outside the private sector. This is a little different than our standard retirement discussion -- but I'm sure many of you will find it interesting.
Dear Gail -
I have a government job with the state where I live and we have a 457 type of retirement plan. I get full retirement benefits after 25 years, which will occur this year. I'll only be 53, so I plan to get an other job,
perhaps teaching at the local community college. Another option is to go into business with my brother.
I could leave the money in my 457 account when I retire, but I'm thinking of rolling the money ($264,000) into an IRA instead. Is there any reason I shouldn't do this?
Thanks,
Mike
Dear Mike;
A 457 plan is a type of retirement plan only available to governmental employees, such as those who work for city, county, or state government. The Tax Relief Reconciliation Act of 2001 (EGTRRA) made a number of welcome changes to 457s, such as increasing the annual contributions so they are in line with what someone covered by a 401(k) could contribute ($14,000 this year). But 457s still differ from other retirement plans in several ways.
For one thing, unlike any other retirement plan there is no "early withdrawal" penalty if you take money out of a 457 plan after you retire -- REGARDLESS OF YOUR AGE. Of course, you will still have to pay income tax on this amount.
However, if you roll over your 457 money into an IRA, the IRA rules take over. These impose a 10 percent penalty on withdrawals taken prior to age 59 1/2 unless you meet one of the exceptions listed under Section 72(t) of the tax code. Exceptions include using the money to pay for college expenses, toward the purchase of a first-time home, or health insurance premiums after you've been out of work for 12 consecutive weeks. If you become disabled, the 10% penalty is also waived. And if you die, your beneficiary can withdraw money from your IRA without penalty, regardless how old he/she is.
So if you think you might want to tap your retirement money to start that business with your brother, you're better off leaving it in your 457 plan.
Another consideration involves whether a creditor can go after your retirement money if you file for bankruptcy. April Caudill is the managing editor of "Tax Facts," which is a key source of tax information. She points out that since a 457 is not a "qualified" retirement plan, it does not enjoy the absolute creditor protection extended under federal law to profit-sharing plans, defined benefit plans, and others. But neither does an IRA.
So if you think bankruptcy might be an issue at some point in the future (just how successful do you think this venture with your brother will be?), you should compare the level of creditor protection you get in your 457 plan against what you could expect from an IRA. Glen Sulzer, a Senior Tax Analyst at CCH, a leading provider of tax information, says the "trend" is for bankruptcy courts to rule 457 plan assets off-limits. "But," he says, "you can't rely on it."
Both 457 plans and IRAs are generally protected to some extent under state law. But the degree to which they're protected varies from state to state. And each plan is probably addressed separately. "It's possible," says Caudill, "that a 457 plan would have a higher level of protection than an IRA." This is the case in New York state, for instance.
On the other hand, rolling over your retirement plan into an IRA will give you more choice over the type of investments available and more control over how the money is distributed if you die.
For instance, if you name anyone other than your spouse as the beneficiary of your 457 plan -- your kids, grandchild, etc.-- the plan might require them to clean out the account by Dec. 31 the year after your death.
A spousal beneficiary would be able to roll the money into an IRA and continue the tax-deferred nature of the account. For other beneficiaries, this option is not available and income taxes would be due that year.
Once the money is in an IRA, a non-spouse beneficiary can choose to "stretch" out the life of the IRA and just take out a minimum amount each year.
When people think "retirement" their knee-jerk reaction tends to be "rollover." In many cases this absolutely is the right choice. But it shouldn't be automatic. Talk to an experienced financial planner and/or tax preparer and review your full financial situation before you make a decision you can't reverse.
Happy retirement!
Gail
Hi Gail,
My question concerns transferring 403b funds. We work for a non-profit organization and we're saving in its 403b plan (making about 7 percent annually). On the advice of a financial advisor we rolled the balance in my husband's account ($100,000) into an annuity 4 or 5 years ago.
Big mistake. It went down a lot. Recently, it started going up, but if we cashed it in today we'd still only get $84,000, unless my husband dies, of course. Then it would be worth $100,000.
My question is, could we transfer that $84,000 BACK to the 403b plan, which is getting about 5.5% interest presently? Or should we just let it sit there and hope for the best?
Joyce
Dear Joyce,
First of all, what kind of annuity did you roll your 403(b) money into? I'm going to assume that you didn't have to pay income tax at the time of the rollover, which would make this a "qualified" annuity. In other words, your annuity is being held inside an IRA. If this is the case, then you may have some flexibility.
(If you paid income tax at the time of the rollover, then there is no way you can get the money in the annuity back into your 403(b).)
The 2001 Tax Act made significant changes to the rules which govern how you can move your retirement money around. In a nutshell, these accounts are now much more "portable" than ever before.
Theoretically, someone could leave a job in the private sector and roll their 401(k) balance into the 457 plan offered through the local government job they just started. If they leave public service and take a job with a non-profit organization, they're now permitted to roll their 457 assets into the 403(b) plan provided by their new employer. Although most people think of IRAs as retirement accounts you roll money INTO, the law allows you to also roll money OUT of an IRA and into an employer-sponsored plan.
But the operative word here is "theoretically." The plan sponsored by your employer must ALLOW money to be rolled in from other retirement accounts. If it doesn't -- and it does not have to -- you cannot roll your IRA annuity back into your 403(b).
But even if it does, there are important issues to consider before you rush into this. First of all, does your annuity pay a fixed rate of interest or can it invest in a variety of things, including stocks? If it's the latter, then you have what is called a "variable" annuity, because the return varies based on the performance of the underlying investments. If these consist mainly of stocks, you shouldn't be surprised that your annuity went down in value from 2000 through 2002 or that it has recouped some of its value recently. Just look at what happened in the stock market during these time periods!
Furthermore, as you point out, the "cash value" of your annuity has gone down, but the "death benefit" is still equal to the amount originally invested. This is a benefit of annuities that can get overlooked when you're just focusing on what it would be worth if you cashed it in. Assuming you are the beneficiary of this annuity, if your husband dies, you will receive $100,000, regardless what the annuity investments are actually worth. Does your 403(b) offer this kind of protection? I doubt it.
Last but not least, an annuity carries "surrender charges" which are subtracted if you cash it in prematurely. Generally these expire after you've owned the annuity for seven years. In some cases, the timeframe might be shorter. So before you cash in your annuity, find out what these might cost you.
Personally, before making any change, I'd sit down with my financial advisor and have a heart-to-heart. Let him/her know what your concerns are. Find out what your annuity is invested in. Make sure it's an asset allocation you can live with and not one that's going to send you into a panic every time the stock market declines.
Hope this helps!
Gail
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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.
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