"He wanted us to look at the account." That's how Neil Brown, a financial planner with Burkett Financial Services and Advanced Financial Planning in Columbia, S.C., describes a recent request from a local attorney. "He had an IRA that was held at a major brokerage firm and wanted our opinion on how it was doing."
This IRA was a bit overweight in large-cap equities, Brown determined, but the return seemed adequate. "When we checked more closely, however, we discovered the beneficiary designation was blank. I called the broker, who told me, The client never got back to me with that information.' After I explained the possible consequences, the attorney became a client of our firm, bringing $1 million in assets including an IRA worth more than $500,000."
Planners can draw several conclusions from Brown's experience. One, the IRA market can be extremely lucrative. Two, advisers who make the right moves can expect to bring some of those IRA dollars into their own practices. And three, expert knowledge of the complex IRA rules can be a key factor when competing for these accounts with other institutions.
In the above situation, the client already had rolled money from an employer-sponsored retirement plan to an IRA, and such accounts may well be in play for perceptive planners. Additional amounts will continue to flow from employer plans to individual accounts: Cerulli Associates, a Boston-based consulting firm, puts 2003 rollover contributions at $150 billion, bringing the total IRA market to $3 trillion. Financial Research Corp., another consulting firm in Boston, has an even higher number for 2003 rollovers$209 billionand projects that rollovers will top $400 billion annually by 2010.
A recent FRC report says that two demographic elements provide an underlying foundation to these IRA trends. Aging baby boomers will retire, shifting money from company plans to IRAs, while increasing job mobility will convince departing employees to take their money with them. "Job changers tend to produce more rollovers, but retirees tend to have higher balances," explains Chris Brown, vice president and director of retirement market research at FRC, adding that both markets may offer opportunities for financial planners.
"If the economy improves, more jobs will be available, and more people will leave their employers, creating more potential IRA rollovers," says Kevin O'Fee, managing director and head of the Rollover Consulting Group at New York Life Investment Management in Parsippany, N.J. O'Fee's parent company is the sponsor of the 2004 MainStay Funds Across Generations survey, which also provides evidence of the growing popularity of rollover IRAs. When asked, "If you left your job, what would you do with your retirement account?" at least half of each group (generation Xers, boomers, and matures) said they would roll the money into an IRA.
Fidelity Investments, which has spent years seeking these accounts, also acknowledges the growing importance of IRA rollovers. "A few years ago, when the stock market was falling, it seemed hard for investors to focus on rollovers," says Dan Besse, vice president of retirement marketing in Smithfield, R.I. "Many investors were reluctant to do anything at all. Now investors are willing to make decisions, and advisers are benefiting by being active in this area."
As market conditions improve, changing tax laws are playing a role as well. Greg Plechner, senior wealth manager at Greenbaum and Orecchio, a planning firm in Old Tappan, N.J., says that the "portability provision" of the 2001 tax act has enhanced participants' ability to transfer retirement plan balances from one account to another. After-tax contributions can be rolled over to an IRA, for example, while pre-tax IRA contributions can be consolidated with rollover IRAs.
"For advisers who are fluent in these rules, there are many opportunities to capture rollovers that would have otherwise remained in ex-employers' plans," Plechner says. A huge market is out there, and the prospects may be particularly bright for planners. "Financial planners are well-positioned to capture rollover money," explains Luis Fleites, a senior analyst at Cerulli. "They know their clients, and they know their clients' assets. Planners who are in touch can recommend an IRA rollover when clients retire or switch jobs."
"Mining client data" is the "number one strategy" for planners to follow to unearth rollover money, according to Fleites. That is, existing clients may have potential rollover accounts. Not all planners are tapping this mother lode, though.
"In our recent study, 50% of advisers surveyed expect an increase of more than 16% in their client rollover assets during the next five years, and 11% of advisers expect their client rollover assets to increase by more than 40%," Fleites says. "But 28% of those advisers indicate that they currently have no plans to implement a strategy that's designed to increase their rollover business."
Planners who have a strategy for obtaining client rollover dollars report considerable success. "When we do an investment policy statement for clients, we often find other assets," says Diane Pearson, director of financial planning at Legend Financial Advisors in Pittsburgh. "They may have left retirement accounts with former employers, thinking that someone is paying attention to them." Generally, though, such assets are just sitting in the former employer's plan, unmanaged.
"People don't know that they have other options," Pearson says. "They don't know about rollovers, and they may think that they must keep the money in the old plan until age 65. We educate them, and we bring in those rollover accounts. It's been an easy conversation, but no one has had it with them."
If planners review client assets, rollover opportunities may arise from sources other than former employers. "One client showed us an account with a brokerage firm that was listed as a profit-sharing plan," Pearson recalls. "The client didn't even remember where it had come from. It turned out that he must have had some self-employment income 20 years earlier, and this account was from a Keogh plan. We obtained this $70,000 rollover as a result of asking to see all client statements, which we use to help put together a comprehensive plan."
A thorough look at client records not only may turn up forgotten accounts, it may point to potential portfolio problems. "A number of clients have come in to us this year with pieces all over the place, from jobs they left a long time ago," says G. Mike Crawford, CEO of LifePlan Financial Group in Dayton, Ohio. "Some of these add up to sizable amounts that clients aren't tracking. As a result of this neglect, a client's portfolio may be grossly out of balance."
One couple, Crawford recalls, recently made an appointment because of a recommendation from the wife's mother, a current client. "They indicated that they had about $200,000 to invest," he says. "We found out they had about twice that much, including old 401(k) accounts from former employers. Looking at the total picture, they were extremely overweight in large growth stocks. We're helping them to roll over those 401(k) accounts to IRAs and managing their overall holdings."
Even when clients are aware of what they have in their 401(k)s, asset allocation may be far from ideal. "In employer-sponsored plans, the investment choices often are suboptimal," notes Marjorie Fox, principal of Rembert, D'Orazio & Fox, a planning firm in Falls Church, Va. "Some asset classes are missing." There might not be a real estate fund, for example, or a small-cap international fund.
"If this seem to be an issue, we begin to have conversations with our clients, pointing out the problems inherent in their employer-sponsored plan," Fox says. "We start to sell the idea of an IRA rollover long before they retire. Without this process, some clients might keep the money in their former employer's plan and not do a rollover."
Some clients may be reluctant to move away from an employer's highly structured 401(k) plan. "Employees often feel that the funds in the plan were pre-screened," explains Patrick Doland, president of Reason Financial Advisors in Northbrook, Ill. "It gives them a level of comfort. They think that their employer has done some due diligence. If there are 12 funds on the list, those must be good funds. When they roll over to an IRA, the choices are unlimitedwhere do they start? Many people in that situation are confused." By convincing clients that astute advice is available, planners may be able to overcome such rollover reluctance.
To provide judicious advice, planners should know as much as possible about their clients, which can be a challenge when clients are baby boomers (now age 40-58). "For many baby boomers, most of their net worth is held in a 401(k) plan and their house," says Bedda D'Angelo, managing director of Fiduciary Solutions in North Andover, Mass. "When I opened my practice, though, it was evident that most planners do not offer ongoing management and monitoring of 401(k) assets." Therefore, D'Angelo determined that providing such services could set her apart, with special appeal for boomers.
"From day one, I offered integrated asset management of all client assets, including those in 401(k) and 403(b) plans," she says. "For those assets, it's a lot of work getting the data and entering it manually into my portfolio management system. The effort is beginning to pay off, though, as my clients roll retirement nest eggs larger than $3 million into IRAs."
Now, when D'Angelo's clients decide to take early retirement, other interested parties come sniffing around. "Salespeople approach these clients all the time, but I just laugh," she says. "I already have these assets, and I'm retaining them because of relationships that I've formed years earlier. The analysis and decision for distribution of retirement assets is made anywhere from 12-24 months before the client actually has access to the assets."
Planners can mine existing client relationships, not only for rollover money but also for new clients likely to bring rollovers with them. "I always ask my existing clients for the names of people they know, age 50-62, who might need comprehensive financial planning," says Saul Simon, a planner in Piscataway, N.J. "My clients are more than willing to help me out here."
What's more, focused marketing efforts can substantially swell the rollover flow. "Ever since the early 1990s, I have positioned myself to serve clients who have been downsized from local companies," Simon says. "I hold in-house workshops where I offer financial planning to these employees. Among the topics we discuss are 401(k)-to-IRA rollovers and pension max' strategies, using life insurance." When companies lay off employees, substantial amounts of money may be available for IRA rollovers.
"The downsizing wave is continuing, and a lot of the people who are being let go have $500,000 or more in their 401(k) accounts, even if they didn't have huge incomes," he adds. "They had the idea in their heads that the company took care of them,' when it came to retirement planning, but they see the light when I explain some of the problems of keeping money in their 401(k)s. Investors think that they're not paying fees inside of an employer's plan, but in some cases the fees are huge, even though the participants don't see them."
Companies that have announced downsizing moves may be willing to join forces with a local financial planner; the same goes for outplacement firms hired to help employees who have been fired. "Some outplacement firms have given me permission to meet with the downsized employees at the firm's office," Simon notes. In these sessions, he goes over multiple issues, which can be both financial (health insurance, pensions) and psychological.
"For example, one woman in her late 40s called for an appointment after sitting through my hour-and-a-half workshop," Simon recalls. "She had just been downsized, she was thinking of going into business with her husband, and our planning session gave her the confidence to go ahead. As a result, we picked up a rollover IRA from her, which we combined with some 401(k) money that she had left with a former employer. We also helped her with life insurance needs as well as a 529 plan; in addition, she referred her mother-in-law to us as a new client."
Simon has a local radio show on which he airs retirement-related issues. "I do some public speaking on subjects such as where do I take retirement money from, what happens when I die, should I make gifts, and do I need long-term care insurance. It's a niche I've created for myself, and which helps me attract clients age 50 and older."
Other advisers also focus explicitly on mid-lifers. "My target market for the past 10 years has been people in their mid- to late 50s," says Bernie Kiely, a planner in Morristown, N.J. "When I get NAPFA referrals, for example, I pay more attention to this age group." His Web site also emphasizes retirement planning services for the 50-plus crowd.
"At that age, people want to know if they're making a mistake by retiring," Kiely says. "They want reassurance that they'll be okay. After they retire, they need someone to tell them if they can pay cash to buy a car or if they can make gifts to their kids. (I tell them, not a dime unless you're sure you'll have enough for yourself and your spouse.) As a result of this emphasis, my practice has been growing, and about half of the funds we manage are in IRA rollover accounts."
Some planners, then, make it a point to seek out clients who one day will be ready to roll. Bruce Brittain, a planner in Alpine, Utah, likens luring IRA dollars to fly fishing. "In fly fishing, you let the fly gradually drift down, in a pool of water, until a trout grabs it."
Brittain's pool, in this analogy, is a company-sponsored retirement plan. "My entire focus is on 401(k) plans with at least $10 million in assets. I'm now working with the participants at three large plans, and I'm looking for others. This allows me to meet regularly with hundreds of employees. As they retire or change jobs, I gain access to their rollover IRAs." Large or small, those rollover IRAs may lead to other opportunities as well.
"I recently worked with an executive who left a company I was working with," Brittain recalls. "He wanted my help with a $300,000 retirement account. We rolled it to an IRA, managed by a TPA [third-party administrator], and I'm splitting that fee. Outside of the IRA, he's investing in a variable annuity, with certain living and death benefits, because he doesn't want to risk the market losses he suffered a few years ago."
The executive's new job involves extensive travel to developing nations, which raised some additional concerns. "He no longer has any group life insurance from his employer, so he bought a $3 million life insurance policy," Brittain says. "I've also helped him to revise his will and create trusts. He's concerned that his wife may not preserve all of her assets if she becomes a widow, so the plan calls for substantial assets to be held in trust, with me as the investment manager."
So being in the right place at the right time can help planners bring in IRA rollovers as well as other business from new clients. A thorough understanding of the intricacies of the IRS rules enhances the likelihood of actually winding up with new engagements.
"One argument in favor of an IRA rollover is the ability to convert to a Roth IRA," D'Angelo notes. "Technically, you have to roll to a traditional IRA first and then do a Roth IRA conversion, but you can do all the paperwork at once. A Roth IRA can be performed only when the client's income doesn't exceed $100,000, so the first year of retirement often is ideal."
Recently D'Angelo worked with a couple where the husband was already retired and the wife was about to finish a career at a local university. "We went over the numbers and determined it made sense for her to do the Roth conversion now, paying the income tax," she says. "If clients can stomach paying the tax and understand the time value of money, the tax-free buildup of a Roth IRA can be an excellent choice. In her case, nearly $1 million that she had in employer accounts was moved into a Roth IRA."
Planners also can demonstrate expertise on the topic of IRA beneficiaries (see "Passing Thoughts"). As mentioned above, planner Neil Brown wrested a rollover IRA from a wirehouse by noticing that no beneficiary had been designated. In such situations, the IRA generally will be left to the account owner's estate, the funds will pass by a will, and the heirs won't be able to stretch out minimum distributions.
Just as knowledgeable planners will know the rules about IRA rollovers, they also know when rolling can force a client off the edge of a cliff. "It's almost always a good idea to roll to an IRA," says David Mendels, director of the New York office of Creative Financial Concepts, which is based in Sedona, Ariz. "However, the liability protection of an IRA, which is governed by state law, may be substantially different from the liability protection of a qualified plan under federal law. Some clients, such as surgeons with substantial malpractice exposure, may be better off keeping the money instead in an employer-sponsored plan."
Such concerns also may affect clients who don't have malpractice worries. "I was discussing rolling a 401(k) balance to an IRA with one of my clients," says Eve Kaplan, a planner in Berkeley Heights, N.J. "She's interested in index funds, so she could reduce her annual expenses, compared with what she's paying now. I told her that doing a rollover would cost her a chance to borrow money easilyparticipants in many 401(k) plans can borrow half their balance, up to $50,000. In addition, I warned her that money in a 401(k) has more protection than an IRA, in case of bankruptcy or divorce. She assured me that she was comfortable with her marriage, so she went ahead with the rollover."
Once clients go ahead with a rollover, knowledge of the rules remains vital. "There are restrictions on IRA investing," says Larry Torella, a tax partner at Eisner, an accounting firm in New York. "IRAs can't invest in collectibles, for example, and IRAs can't be leveraged, so you can't invest on margin inside the account. If you invest IRA money in a hedge fund that does significant borrowing, you might pick up unrelated business taxable income." Similarly, holding leveraged closed-end funds inside an IRA may create tax problems.
"In addition, remember that all IRA withdrawals come out as ordinary income," Torella adds. "When you are managing the investments inside an IRA, you should realize that the difference between a short- and long-term holding period is essentially meaningless." In other words, once clients have rolled them, planners need to know how to hold them.
SIZING UP THE OPTIONS
When changing jobs or retiring, clients have four basic options to consider when deciding what to do with their retirement account savings. Here's a summary of the pros and cons of each:
Option: Take Your Savings in Cash
Pros
- Immediate access to a portion of your money
Cons
- Savings no longer grow tax-deferred
- A 10% early withdrawal penalty generally applies to people under 591/2
- Subject to all applicable federal, state, and local taxes
- Without compounded growth, may compromise your wealth in retirement
- Distribution may push you into a higher tax bracket
Option: Roll Your Savings into an IRA
Pros
- Money continues to grow tax-deferred
- Avoid the 10% early withdrawal penalty if you're under 591/2
- Additional investment options may be available
- Retirement assets are consolidated
- Control how to access savings
- Flexibility to move IRA rollover assets into a future employer's plan
- Potential to convert assets to a Roth IRA in the future
Cons
- No immediate access to full amount of account
- Mandatory distributions at 701/2
- Tax-deferral on future earnings of after-tax assets (if applicable) endsbeginning on Jan. 1, 2002, contributions to a qualified plan may be rolled into an IRA if certain requirements are met
Option: Keep Your Savings in Your Previous Employer's Retirement Plan, If Allowed
Pros
- Money continues to grow tax-deferred
- Avoid the 10% early withdrawal penalty if you're under 591/2
- Little or no paperwork
- Asset allocation strategy remains intact
- May allow you to withdraw money without penalty under certain circumstances
Cons
- Plan may place limitations on inactive or retired participants' accounts
- Investment options limited to those offered in the plan
- Withdrawals and distributions are subject to plan provisions
- Company may be acquired and/or change its plan in the future
Option: Move Your Savings Into Your New Employer's Retirement Plan
Pros
- Money continues to grow tax-deferred
- Avoid the 10% early withdrawal penalty if you're under 591/2
- New plan may allow loans
- Investment options and features may improve compared to old plan
- Retirement assets are consolidated with one provider
Cons
- New plan may have higher fees than the old plan
- Investment options are limited to those offered in the plan
- Withdrawals and distributions are subject to plan provisions Source: New York Life Investment Management.
This article originally appeared in the November 2004 issue of Financial Planning magazine.