Tip of the Week: Issues to Consider about Rollovers in General

Editor’s Note: This is an occasional feature in the NTSA Advisor. It is drawn from The Source, a book that covers technical, compliance, administrative and marketing aspects of the 403(b) and 457(b) markets. More information about The Source is available here.

Tip of the Week concerns general issues to consider about rollovers.

Accepting Rollovers in Employer Plans. In employer plans, including 403(b) plans and governmental 457(b) plans, the plan terms and conditions are governed by a plan document. IRA values may be rolled into such plans, but the terms of the plans have to be reviewed to understand what conditions apply to the amounts rolled over. The first feature to review is whether or not the plan accepts rollovers and if there are any conditions attached to that acceptance.

Direct Rollover Options Must Be Provided. For years after 2001, qualified plans, 403(b) plans and 457(b) governmental plans must permit the direct rollover of any eligible rollover distribution from the plan. As previously explained, a direct rollover is the only method available to avoid the mandatory 20% federal income tax withholding that would otherwise apply to distributions that are eligible for rollovers.

Indirect Rollover. If a participant receives an eligible rollover distribution from a qualified plan, a 403(b) plan or a 457(b) governmental plan which is paid directly to him or her, 20% of the taxable amount distributed (for federal income tax) must be withheld. If the individual intended to rollover 100% of the distribution, the participant will need to replace the 20% withheld from some other source such as personal savings. If only 80% is rolled over, the remaining 20% will be taxable and may also be subject to the 10% penalty tax (except for 457(b) governmental plans). The individual has 60 days from receipt of the distribution to complete the rollover and can choose to rollover all or any portion of the distribution.

Suitability of the Rollover. In addition to the Conflict of Interest Regulations, there is growing scrutiny by regulatory agencies on whether a rollover from an employer-sponsored plan is suitable. In fact, FINRA issued Regulatory Notice 13-45, in December 2013, which announced that the suitability issue will be a focus of FINRA examinations beginning in 2014 in which broker/dealers will be examined in terms of their practices in recommending the rollover of plan assets to an IRA. The notice is very detailed in the matters that will need to be considered before recommending such a rollover and the actions that must be taken by broker/dealer firms to ensure that their registered representatives are following the proper practices and procedures. Among the factors that must be considered are:

1. Whether the wider array of investment options available in an IRA is superior (in the eyes of the investor) to the potentially low-cost institutional funds available in the employer sponsored plan.
2. A detailed comparison of the fees charged in the plan versus the fees in the IRA.
3. The impact of the penalty-free withdrawal available in the plan for employee who leaves the employer between the ages of 55 and 59½ versus the penalty tax that continues until age 59½ in the IRA.
4. Protection of assets from creditors and legal judgment. Depending on state law, if we are dealing with a non-ERISA 403(b), plan assets may have greater protections than in an IRA.
5. Required Minimum Distributions which need not be taken from the employer sponsored plan until the later of age 70½ or the year employment is severed versus the requirement that such distributions be taken from the IRA at age 70½ regardless of employment status.
6. The tax consequences of rolling over appreciated stock (which, after a rollover to the IRA would be taxed as ordinary income when distributed), which of course would not be seen in the 403(b) market.

Firms are reminded that Rule 2111 includes the fundamental responsibility for fair dealing, and are also reminded that their Registered Representatives must be properly trained, and must also ensure that any communication regarding rollovers from employer plans are fair and balanced, and provide basis for individuals to evaluate the facts relative to the rollover adhering to the guidelines of FINRA Rule 2210.