Tim and Joyce came to see me a few weeks back. They live in Pembroke, are both in their early 40’s, and have three boys ages, 14, 11, and 8. Their parents, let’s call them Steve and Joannie, are current clients of mine and they thought it was time Tim and Joyce sought some professional advice to help them take control of their financial lives.
Tim’s a seasoned software salesman who’s got a lot of experience under his belt. Joyce does all she can to shuttle around three active boys and provide a nice home for a family of five. After beginning to build out their retirement system I realized that Tim has moved between jobs quite a bit over the years. Some companies have gone under, others have been acquired, and in some cases, he’s moved on for better opportunities.
It was time for Tim to change employers again. Tim had been made a lucrative offer by another firm, and he jumped at the chance. The new job means a bit more travel for Tim, but he’s up for the challenge.
Tim’s a top earner, an aggressive salesman with a proven track record. Between rollovers from past employers’ retirement plans and his aggressive contribution schedule, he’s built up a significant balance in his current employer’s 401(k) plan. But complicating things for Tim was this recent market turndown at the end of 2018. Tim saw his 401k drop over 27% within 90 days with no floor. In other words, Tim had no control.
Hmmm…Tim wants more control.
One of the challenges inherent within most 401k’s is the lack of flexibility and selection of product and strategy. Most plans have 10-15 choices of product, usually mutual funds, built within an outdated buy and hold investment strategy. Most plans will try to track to a market index, such as the S&P 500.
After we back tested Tim’s current strategy to show him how his plan will behave in times of significant volatility, the picture became much clearer for him.
It was time to teach Tim how to get more control.
I explained to Tim that whenever you change jobs, it’s always a good idea to take stock of your retirement plan. Generally speaking, since Tim is going to change his employment he has three options available to him regarding his 401(k). Tim could cash out his account and take a lump sum distribution, leave it where it is with limited product and an outdated investment strategy, transfer it to his new employer’s 401(k) plan, or roll it over into an Individual Retirement Account (IRA).
Tim, like most of us, ruled out cashing out his existing 401(k) plan through a lump sum distribution. Not only will he be responsible for all state and federal taxes but because he is under age 59 ½, he is also looking at an additional 10% penalty for touching that money early. A lump sum distribution will also bump up Tim and Joyce’s reported income for 2019 and move them into a higher tax bracket. Quite frankly, not a very good choice for most folks, and definitely not a good choice for them.
Tim could certainly rollover his existing 401k into his new company plan. However, back-testing his new plan’s options through some difficult years, Tim was reluctant to do so. Tim discovered that his new company plan lacked investment choices and followed an outdated buy and hold investment strategy similar to his previous employer’s plan. That will not give them the control they both desire.
So we discussed rolling over his old 401k’s into a Traditional IRA (IRA). An IRA can give him a far wider landscape of available financial products. Products like individual stocks, bonds and bond funds, Certificates of Deposit (CDs), Exchange-Traded Funds (ETFs) and other financial instruments often used to meet financial goals. I also introduced Tim and Joyce to IRA strategies that integrate Downside Risk Mitigation (DRM) techniques which will help to give them better control over their investment strategy.
You see, DRM seeks to employ historical quantitative data to help to give the IRA the highest probability of when to be invested during times of market appreciation. However, an IRA that incorporates DRM will also use quantitative data to help side-step and move to a safe-haven during times of significant market volatility as seen in the last quarter of 2018.
We walked through some time-tested IRA strategies. Strategies that combine a wider landscape of financial products with a much more flexible and appropriate DRM techniques. Tim and Joyce’s retirement roadmap became much clearer.
Tim lifted his head and said softly, “It really is not about trying to get all the gains, is it?”
By taking them through a defined process, it became very clear to both Tim and Joyce that over time if they can manage the downside risk and avoid or at least limit the massive losses, the upside can take care of itself.
Tim and Joyce are about to take control.
I went on to explain to them that there are no taxes or penalties imposed on investors who choose to roll over their 401(k) balance to a traditional IRA. Taxes continue to be deferred until a withdrawal is made.
However there are some other important things they need to consider before making the shift to an IRA. They can’t take a loan from an IRA, as they can with most 401(k) plans. But the IRS does provide mechanisms to enable IRA account holders to use their funds to pay for certain qualified expenses. Those include qualified higher education costs (both for one’s self and one’s family), medical expenses, and even to put towards a first-time home purchase down payment.
Folks, the regulations for doing so can get a bit complicated. It’s best to work with a specialist to make sure that all the rules are followed.
After Tim and Joyce reviewed their options, they moved all of his retirement investments from his ex-employer’s 401(k) plans to his new rollover IRA. They are now able to make more appropriate choices that may help them feel like the masters of their destiny, rather than just another couple of wheels in the machine.
Tim and Joyce have now put themselves in a much better position to take control of their financial future.
Like Tim and Joyce, I encourage you to be vigilant and stay alert, because you deserve more.
Have a great week!
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, a wealth management firm with offices in Falmouth, Duxbury, and Mansfield. Jeff can be reached at firstname.lastname@example.org.
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