Maximizing rollover opportunities

The United States has one of the most mobile work forces in the world. Every year, some 5 million of us change jobs. In addition, a growing number of the 78 million baby boomers are entering retirement. This all contributes to a 401(k) rollover market that is projected to top $221 billion this year.

Since rollover assets represent a large percentage of many peoples’ net worth, financial advisers should know how to preserve the tax-deferred status of these funds once they leave a qualified plan, as well as build the assets in the context of an appropriate financial plan.

But while the rollover process itself is simple, situations involving extended families, beneficiary designations and beneficiary planning, all of them common, can quickly add complexity. And since mistakes can be expensive and irreversible, it pays to get specialized training in rollovers.

Today, some 40% of American workers cash out of their retirement savings when they leave jobs, according to the 2007 Principal Financial Well-Being Index. That study, which surveyed retirees and working adults at growing businesses, for the first time revealed that respondents’ long-term financial future ranked higher than job security as their top concern.

Clearly, these two forces — the demographic shift into retirement combined with concern over one’s financial future — present a significant need for the expertise that advisers bring to the table. But to identify needs, advisers must be able to listen carefully and engage their clients.

Here are three key areas where an adviser’s expertise can add value:

Beneficiary designations. While it seems obvious, all named beneficiaries listed on a beneficiary form must be living. Over time, however, named people die. Divorce also changes beneficiary choices, and people often forget to update their important papers. These omissions are often costly and impossible to change.

Take the case of a woman who left a $1 million retirement plan to her husband in her will. Unfortunately, the money went to her sister because a beneficiary form the woman filled out 40 years earlier when she was single made her sister the primary beneficiary and her parents contingent beneficiaries — and beneficiary forms override wills.

Do you talk to your clients about beneficiary designations? Advisers can use these conversations as an opportunity to better know their customers. They should check all beneficiary forms their clients have completed, including forms for accounts which aren’t under the registered representative’s direct management.

Stretch IRAs. Commonly misunderstood, the stretch individual retirement account is open to anyone. It keeps inherited assets tax-deferred for beneficiaries in a traditional or Roth IRA for as long as legally possible. Since most employers don’t counsel exiting employees about the stretch IRA, advisers can provide a distinct benefit by planning for the conversion of 401(k), 403(b), and 457 plan assets into stretch IRAs upon retirement. It is a great opportunity to discuss retirement planning and the benefits of tax-sheltered compounding for beneficiaries.

Net unrealized appreciation. Many investors don’t know that if they hold highly appreciated company stock in a 401(k), they can take a lump-sum distribution when they retire and pay ordinary income taxes on the stock’s basis. The difference between the basis and the fair market value — the net unrealized appreciation — will be taxed at long-term capital gains rates only when the stock is sold, regardless of how long it is held. If the stock is rolled into an IRA, all its value eventually will be taxed at ordinary income rates.

It is clear that since retirement and investment planning are linked, rollovers present an opportunity to develop a client’s comprehensive long-term goals. Because of their concerns about outliving assets and keeping pace with inflation, investors are considering wider ranges of investment strategies and products geared toward producing higher post-retirement incomes.

One way to address these concerns is to mix a core portfolio in target date or target risk funds with satellite positions in other alpha-seeking asset classes. This also presents another opportunity for advisers to build more customized managed programs.

While job transfers and retirement are emotional issues, advisers should recognize that these life-changing milestones present exceptional opportunities to guide clients and strengthen relationships.

To be sure, serious pitfalls can accompany poorly managed rollovers. But when handled properly, rollovers can preserve hard-earned assets and reduce the burden of taxation.

Tim Hill is the national sales director for Principal Funds in Des Moines, Iowa.