Five IRA Rollover Mistakes to Avoid

Making a mistake when rolling your 401(k) to an IRA could result in unexpected taxes and possible penalties.
Making a mistake when rolling your 401(k) to an IRA could result in unexpected taxes and possible penalties.

Recent changes in the job market have led to an increase in IRA rollovers, but at the same time, people are making more mistakes when transferring their employer related retirement accounts to an IRA, reports The Wall Street Journal in a recent article, “The Biggest Mistake People Make With IRA Rollovers.” These IRA rollover mistakes may result in additional taxes and penalties.

Done properly, rolling funds from a 401(k) to a traditional IRA offers you more flexibility and control. A company retirement plan may limit you to a half-dozen or so investment choices; but, depending on the IRA custodian, the IRA owner may choose investment options ranging from stocks and bonds to mutual funds, exchange-traded funds, certificates of deposits or annuities.

However, if you are considering rolling over an employer related retirement plan to an IRA, make sure to avoid these common IRA rollover mistakes:

Mistake #1:  Taking a lump-sum distribution of the 401(k) funds instead of moving the funds directly to an IRA custodian. The clock starts ticking when you do what’s called an “indirect rollover.” Miss the 60-day deadline and the amount is considered a distribution, included as gross income and taxable. If you’re younger than 59½, you might also get hit with a 10% early withdrawal penalty.

There is an exception: if you are an employee with highly appreciated stock of the company that you are leaving in your 401(k), it’s considered a “Net Unrealized Appreciation,” or NUA. In this case, you may take the lump-sum distribution and pay taxes at the ordinary income-tax rate, but only on the cost basis, or the adjusted original value, of the stock. The difference between the cost basis and the current market value is the NUA, and you can defer the tax on the difference until you sell the stock.

Mistake #2:  Not realizing when you do an indirect rollover, your workplace plan administrator will usually withhold 20% of your account and send it to the IRS as pre-payment of federal income tax on the distribution. This will happen even if your plan is to immediately transfer the money into an IRA. If too much tax was withheld, you’ll get a refund from the IRS.

Mistake #3:  Rolling over funds from a 401(k) to an IRA before taking a Required Minimum Distribution or RMD. If you’re required to take an RMD for the year that you are receiving the distribution (age 72 and over), neglecting this will result in an excess contribution, which could be subject to a 6% penalty.

Mistake #4:   Rolling funds from a 401(k) to a Roth IRA and neglecting to pay taxes immediately. If you move money from a 401(k) to a Roth IRA, it’s a conversion and taxes are due when you make the transfer. However, if you have some after-tax dollars left in the 401(k), you can make a tax-free distribution of those funds to a Roth IRA.

Mistake #5:  Not knowing the limits when moving funds from one IRA to another, if you do a 60-day rollover. The general rule is this: you are allowed to do only one distribution from an IRA to another IRA within a 12-month period. Make more than one distribution and it’s considered taxable income. Tack on a 10% penalty, if you’re under 59½.

Reference: The Wall Street Journal (Oct. 1, 2021) “The Biggest Mistake People Make With IRA Rollovers”

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What Happens to Your Will if You Get Divorced?

It is especially important to review your estate plan in a divorce situation.
It is especially important to review your estate plan in a divorce situation.

Every time you experience a life changing event, including divorce, it’s time to revisit your Will to make sure there are no unpleasant surprises for you or your family. As reported in the article “Rewriting Your Will After Divorce” from Investopedia, failing to review your current estate plan when contemplating a divorce can lead to results that you never intended.

Texas Law Can Save You

Luckily, in Texas we have several laws that cover you if you forget or don’t get around to writing your ex spouse out of your Will. Texas law presumes that after a divorce you do not want a former spouse to be a beneficiary under your Will or to act as your executor or agent under a power of attorney to make financial or medical decisions for you.

In fact, if you do want your former spouse to be your executor or agent, you need to reappoint them in new estate planning documents you execute after the divorce.

One thing to remember is that if your ex is a parent of your children, you will not be able to eliminate him or her as a guardian of your children if something happens to you while they are minors. The only way the other parent will not be allowed to be guardian of his or her child is if the parent is found unsuitable.

But you should still execute a new designation of guardian for your minor children in case your ex who is the parent is deceased or is found to be unsuitable to be guardian.

So, Where’s the Problem?

What if you pass away before the divorce is final? The law only applies to a divorced spouse, not if you are only separated or waiting for the divorce to be final. That’s why it’s a good idea to change your estate planning documents when you’re contemplating a divorce.

Issues With Some Retirement Plans

Also, Texas law cannot override a very harsh US Supreme Court case holding that state law does not apply to employer related retirement plans, such as 401(k)’s and 403(b)’s. These kinds of retirement benefits are subject to federal law which supersedes state law.

This US Supreme Court case, Egelhoff v Egelhoff, was decided in 2001. Mr. Egelhoff, an employee of Boeing Company, had a pension and life insurance policy that was provided by his employer.

Mr. Egelhoff, died in a car accident two months after his divorce, but before he changed the beneficiaries on his retirement and company life insurance.  Though the company still listed Mr. Egelhoff’s ex-wife as beneficiary, Mr. Egelhoff’s children by a previous marriage claimed that he had every intention of removing their stepmother as beneficiary and naming them, his children, as beneficiaries. That would seem to make sense given the circumstances.

Mr. Egelhoff’s children sued their father’s ex-wife for the retirement benefits and the life insurance, claiming that there was no way their father wanted his ex-wife to have the benefits to the detriment of his children.

The Court said that, under federal law, the company’s plan documents control who the beneficiary is and that the benefits would be distributed to the person who was listed with the company as beneficiary at the time of death, even if the beneficiary had been recently divorced from the employee.

The moral of the story is to make sure that beneficiaries on company related benefits are changed immediately after divorce to avoid the unfair result that happened to the Egelhoff children. State law cannot save you in that situation.

What’s Our Takeaway from This?

Every time there is a major life event (divorce, death of a family member, marriage, increase or decrease in wealth, illness, etc.) it is time to review your estate plan to make sure that it reflects what you want and need now. If you wait too long, things may not work out the way you want them to for your family and yourself.

Reference: Investopedia (September 14, 2021) “Rewriting Your Will After Divorce”

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Responsibilities of an Agent under a Power of Attorney

The concept of a power of attorney sounds simple but there is a lot to know about this important part of an estate plan, says the Rushville Republican in “Financial power of attorney responsibilities.” Whether you are named as someone’s power of attorney or you are considering who to name on your behalf, it is important to understand the terminology, the role and the responsibilities.

The person who signs the POA is called the “principal” and the person to whom authority is given, is often referred to as the “attorney in fact” or the “agent.”

What powers are given to the person who becomes the agent?  The POA provides what powers the agent will have, but generally the idea is the agent can do whatever the individual would do. That includes opening bank accounts, buying and selling property, managing investments, filing taxes, cashing checks and closing accounts. An agent is a considered a fiduciary of the principal, which means that he has a legal duty to act in the principal’s best interest.

The POA generally is not recorded in a courthouse. If you are signing a document for the principal that does have to be recorded with the county, like a deed to a house, then you will need to present and record the POA with the county recorder, before the document can be recorded. The laws in your state or county may be different, so check with your estate planning attorney to be certain.

The POA should remember to keep his assets and the principal’s assets separate. Money should not be intermingled in bank accounts or investment accounts. This is a very important point, since the fiduciary responsibility is a serious matter. The POA can be changed or revoked by the principal at any time, as long as she is mentally competent.

The POA ends with the death of the principal. It is meant to be used as a helpful tool, while the person is living. After the person dies, the executor takes over as the personal representative of the person’s estate.

Speak with your estate planning attorney about making the decisions as to who should be your Power of Attorney. This is a very important role and it must be someone who you can trust implicitly and who is also willing to take on the responsibilities.

 

Reference: Rushville Republican (Jan. 22,2019) “Financial power of attorney responsibilities”

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