Perils of the 401K to IRA Rollover; Spouses Beware
Earlier today I happened upon a really important article accenting the dangers of what often starts as an entirely innocent transaction. A site called the Street.com publishes a variety of articles about retirement and investing. The one I read was by Marcia Mantell and was published on March 29. Her article is excellent but let me try to re-cast it in a more harrowing yet realistic way.
Bob and Carol are each 65 and have a lengthy marriage. During that marriage Bob had the “big” job with the pharmaceutical company where there were fabulous benefits including the 401K with the company sponsored match. This nest egg allowed Carol to take primary responsibility for raising the kids while working at employment she loved more than it loved her in a pecuniary sense. So, at retirement, Bob had $1,000,000 at BigPharma’s Fidelity Savings Plan (a 401K) while Carol had $50,000 in her Individual Retirement Account.
As Bob is going through “checkout” at BigPharma’s Arizona based “Retirement Center” he is asked what he wants to do with his 401K plan. He asks about his options and is informed that he can keep it at Fidelity indefinitely or roll it into an Individual Retirement Account on a tax-free basis. He mentions this to your neighbor, the local MorganStanleyMerrillLynchWellsFargo guy who highly recommends the rollover to the IRA.
“Look Bob, you got 8 plans you can invest in through the BigPharma Fidelity 401(K). Sure, they’re OK but if you put them into an IRA with me, we can invest the money in a hundred different places, some of which have been yielding some amazing returns. You can even get into the crypto currency market or, options. Your 1,000,000 is a good start but if we play this right, you might be able to double that in a few years.”
If Bob takes the bait, the neighbor ends up managing $1,000,000 of Bob’s money and that entitles him to greater comp with his brokerage. Bob likes the idea because in 2020 he asked if his 401K would let him buy $100,000 worth of Bitcoin and if they had allowed it that $100,000 would be worth $700,000 today and he have been well on his way to a $2 million retirement fund.
As he is clearing out his desk Bob comes to Carol with a form which Carol needs to sign in order to rollover his 401K to an IRA. Carol asks why are they doing this and gets the standard speech about “flexibility in investments” and “opportunities” for greater returns than the stodgy old BigPharma Fidelity Plan. So, she signs and 30 years of 401K is now a brand new IRA.
Oh, what a difference a day makes. Let’s assume that Bob is no cad, just a fellow who likes to play the market a little more widely. At BigPharma Fidelity, they don’t really offer any sexy investments. You can do an index fund, a treasuries fund, a blue chip dividend fund or some other vanilla form of mutual investment. In his new “Let’s Make a Deal” IRA, he starts to speculate in his goal to take $1 million to $2 million in assets within six years. He decided to go long on Tesla and Rivian shares. He bought some energy funds and figured that as the world travel market came back to life he could profit from positions in the aircraft manufacturing business. These weren’t outlandish choices but they weren’t wise ones either. His retirement million is now actually $800,000 even though the S&P index rose 26% in the last 12 months. Does Carol know this? She probably should but both the 401K and its successor IRA are in Bob’s name alone. In fact, neither account can be made joint. She will know only because he tells her or because she steams open the brokerage house IRA statement every month. That might be a crime if she did it. But she is wandering the planet thinking that Bob’s account went up at about the pace of the rest of the market. Too bad it didn’t.
Now let’s assume Bob is not nice. He’s a cad who is sick of Carol and adores his kids from his first marriage. BigPharma’s 401K and every other 401K comes with strings attached. You can’t make anyone other than your spouse a beneficiary without your spouse’s consent. And your spouse would have no reason to consent. So, you die and even though you hate Carol and love those kids you had with Alice, there’s nothing you can do but accept that at death the whole account goes to Carol. Ugh.
Ah, but if you rollover the 401K to an IRA (with Carol’s consent) the restrictions on who you can leave the account to are eliminated. Yep, you can sign a form giving the whole million (now $800,000) to your kids, your mistress, your mom, your dog (although the pup may require a trust). Won’t Carol be surprised when she comes back from the funeral to learn that news? Your Mom will love it as will your kids. They always liked Alice and hated Carol for what “she did” 30 years ago.
This cannot be, right? Or perhaps, this cannot be right. But as the Mantell article says, this is the law in its current state. And not many Carols in the world when asked to consent to a transfer from a 401K to an IRA know that the protections of the Retirement Equity Act disappear once the money leaves a “qualified” plan like a 401K or 403B and becomes an IRA. In sum, there are two risks here and both are huge. The first is that a rollover takes the handcuffs off the pool of possible investments. Rare is the 401K plan that has risky things embedded in its list of available funds. But IRAs are relatively unregulated and the owner of the IRA (always one spouse/never joint) has pretty much total control. The second risk is that the owner gets to name his/her beneficiary and that invites surprises. If someone files for divorce before anyone dies, the court can intervene to keep Carol as beneficiary. But, unless something is done before Bob meets his maker, his beneficiary designation will be followed.
Ms. Mantell rightfully contends these rules are unjust. But until Congress fixes these matters, the law is pretty clear and Carol is a person at risk.
The article:
