Rolling a 403(b) or 457 plan account into an IRA could be worth consideration for many retirees. Making a switch may provide access to greater investment flexibility, portability, and the value of professional management during retirement.
If you're about to retire—or have already recently retired—you have an important decision to make about the money in your 403(b) or 457 plan account: Do you take a lump-sum distribution, or roll it over?
If your plan allows it, rolling over your account into an IRA may prove beneficial to you for a number of reasons.
- More investment options. 403(b) and 457 plans generally offer limited investment options. With an IRA, you have access to a greater range of investments, including mutual funds, ETFs, stocks, bonds, and cash. This allows you to develop a more precise mixture of investments that best reflects your own personal risk tolerance, investment philosophy, and financial goals.
- Lower fees. The fees associated with an IRA can be lower than the expenses in your 403(b) or 457 plan. Fees have a direct impact on your returns. With a wider range of investments to choose from, you could include a fee comparison component as part of your decision-making process.
- Greater flexibility. Some plans allow only lump-sum distributions, and others may limit the frequency of withdrawals. If you roll the money into an IRA, you can take it out on your own schedule, provided you are at least age fifty-nine and a half.1
- More convenience. If you worked at different jobs during your career and you roll all of your previous employers’ plan balances into an IRA, you’ll have a single, consolidated account to track. This makes it easier to monitor your investments, rebalance as appropriate, and schedule required minimum distributions.
Tax Benefits
There are a number of tax benefits to consider, as well. A lump-sum distribution could potentially cost you thousands, as the table below illustrates. In this example, a sixty-five-year-old teacher who is retiring with a $350,000 balance in her 403(b) account would lose more than $4,200 a year if she opted for a lump-sum distribution rather than a rollover.2
|
Lump-Sum Distribution |
|
|
|
Rollover |
||
|
Beginning balance |
$350,000 |
$350,000 |
|
Federal tax liability @ 35 % |
$122,500 |
$0 |
|
Net investable assets |
$227,500 |
$350,000 |
|
Hypothetical Distribution rate of return |
5% |
5% |
|
Estimated annual payments, pre-tax |
$17,386 |
$26,748 |
|
Estimated average annual federal tax |
$1,606 |
$6,687 |
|
Estimated annual after-tax distribution |
$15,780 |
$20,061 |
*Hypothetical Illustration. Not representative of any specific investment
If you directly roll over to a traditional IRA, you don’t need to pay taxes until you start withdrawing money from your account. Note that if you roll over the money from a traditional plan to a Roth IRA, you will have to pay income taxes on the full balance converted in the year you make the conversion. Any withdrawals made after a conversion are tax free once you have attained age fifty-nine and a half and it’s more than five years since the conversion date.
If you have after-tax contributions in your employer plan, you may opt to withdraw them without penalty when you roll over your assets. However, if you wish to leave those funds in your retirement account in order to continue tax deferral, you can include them in your rollover. When you begin regular distributions from your IRA, a prorated portion will be deemed nontaxable to reimburse you for the after-tax contributions.
Professional Support
Managing money in retirement can be complex. How should you invest? How much can you withdraw each year? What about your pension? When should you take Social Security? How do you compensate for inflation?
If you roll over your assets into an IRA, you can more easily access the guidance of a financial professional to help you determine a strategy suitable for you. A financial professional can also help you with your estate planning needs. For example, with 403(b) and 457 plans, heirs must take out all the assets after the account holder dies and face a potentially large tax bill. However, beneficiaries of IRAs may be able to stretch distributions out over their lifetimes.
Footnotes/Disclaimers
1Withdrawals made prior to age 59½ may be subject to a 10% federal penalty.
2Source: S&P Capital IQ Financial Communications. Assumes a 35% marginal tax rate applies to the lump-sum distribution, that distributions are taken annually for 20 years, and that a 25% marginal tax rate applies to the annual distributions. Does not consider the potential impact of state taxes.
If you’d like to learn more, please contact Sharon Dykhouse at 616-974-8923.
Courtesy of Sharon H. Dykhouse. CRPC®, CRPS® Assoc. Vice President, Financial Advisor. Written by: McGraw Hill and provided courtesy of Morgan Stanley Financial Advisor. Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors do not provide tax or legal advice and are not “fiduciaries” (under the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise agreed to in writing by Morgan Stanley. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are encouraged to consult their tax and legal advisors regarding any potential tax and related consequences of any investments made under such account.
The author(s) are not employees of Morgan Stanley Smith Barney LLC ("Morgan Stanley"). The opinions expressed by the authors are solely their own and do not necessarily reflect those of Morgan Stanley. The information and data in the article or publication has been obtained from sources outside of Morgan Stanley and Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of information or data from sources outside of Morgan Stanley. Neither the information provided nor any opinion expressed constitutes a solicitation by Morgan Stanley with respect to the purchase or sale of any security, investment, strategy or product that may be mentioned.
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