The Tax-Efficient Savings Plan for Hourly Employees (and the salaried sister plan the SSIP), is a remarkable financial planning tool for wealth accumulation. No other tool allows the ease and expanse of tax-deferred accumulation as a 401(k) program like TESPHE and the SSIP. However, once you retire, we frequently advise considering a rollover to an IRA. You can make a tax-free transfer (make sure you do a direct rollover) from TESPHE (SSIP) to an IRA. Here are some pros and cons.
Reasons Why an IRA is Better than TESPHE:
1. IRAs have much broader investment choices. In your TESPHE/SSIP, you have a limited number of investment choices with a pretty good range of asset classes, but still limited. In an IRA, you have virtually unlimited choices. Want to buy a mutual fund that covers India? Buy some GE stock? An ETF? You can do it in an IRA. You can even buy investment real estate in an IRA, though we don’t recommend it. Our approach to IRA investing is to create an optimum mix of asset classes and then find the best funds in each asset class. Of course, we use no-load funds. Does a bigger choice of ingredients make a difference? Here is an example: In the TESPHE/SSIP, we feel international investments are very important. The normal choice for international equities is Fidelity Overseas. According to Morningstar®, Overseas had a 10-year rate of return of 5.38%, putting it in the 33rd percentile rank in its category. The Large International fund we use had a 10 year rate of return of 12.37%, with a rank in the 2nd percentile. Over ten years, Overseas would have made $6,888 from a $10,000 investment. The other fund would have made $22,100. Returns matter, and more choices are better.
2. IRAs have better non-spouse beneficiary options. If your primary beneficiary is your spouse, TESPHE/SSIP and IRAs are virtually the same; your spouse can roll it over to their own IRA. If you have non-spouse beneficiaries (like your kids), the process can become considerably more complex in a TESPHE/SSIP. With an IRA, you can ‘stretch’ the IRA to be paid out over their lifetimes (this stuff is different if you’re over 70 ½, but you’re probably not there yet). The ‘stretch’ minimizes the tax bite to the kids and allows them to have a nice retirement income of their own. Be careful with any beneficiary designation. We like to carefully craft the right designations for minimizing taxes, and assure your beneficiaries don’t get overlooked.
3. In an IRA, you can buy or sell any stock at any time of the day. We don’t like day trading, in fact we discourage it. But a nice feature of an IRA is that you can buy or sell a stock (or bond, for that matter) at any time during the trading day. In the TESPHE/SSIP, the Ford stock is actually a ‘Ford Stock Fund’, which allows you only to trade at the close of the day. With an IRA, you can sell Ford stock at any time of the day. In an IRA, it doesn’t have to be just Ford either; you can buy or sell any stocks, bonds or ETFs.
4. You can link an IRA to a bank account. Sooner or later, you will withdraw from your retirement savings. An IRA allows you to ‘link’ your IRA to your checking or saving account. For most of our retirees, we set up a monthly link to deposit the money right in their account without a check that could be lost or stolen. Most of the time we take the taxes out up front, so the retiree doesn’t have to worry about those either. A word of caution: be careful about how much you take out. We strongly suggest avoiding over-withdrawing (like more than 5% a year or so). In these troubling times, try to preserve your principal. Don’t eat your seed corn.
5. You can get money out of an IRA before age 59 ½ using a 72(t) loophole. Normally, you can make any type of withdrawal from an IRA after age 59 ½. If you take money from an IRA before 59 ½, you may be subject to a 10% penalty. There’s a special tax loophole for early IRA withdrawals called 72(t). 72(t) allows you to take money out of an IRA at any age. You have to take substantially equal withdrawals and they have to be computed under a set of rules. In addition you can’t change the withdrawal stream once you start it until the later of age 59 ½ or five years. But, this allows even a 49 year old to make some regular withdrawals from an IRA. How much? Say you’ve been at Ford for 30 years and you’ve accumulated $140,000 in TESPHE. You take the $50,000 buy-out and wisely roll it over into TESPHE, bringing your balance up to $190,000. Say you’re 50, so there’s not a penalty-free way to take your money out of TESPHE directly. You can roll over the $190,000 and start taking distributions. Using the rates and numbers for September, 2008, you could take $10,484 a year (or $874 a month) without penalty until 59 ½. More good news? If you made 7 ½ % on your IRA and took out the $10,484 a year, you’d have about $243,000 by age 59 ½. Take money out and grow the nest egg. Good idea. [Note: 72(t) has some complexities. We recommend you call us or your tax advisor before you make a 72(t) election.]
A Reason Why TESPHE is Better than an IRA:
1. You can take flexible withdrawals at age 55 or older. One good feature of leaving money with TESPHE/SSIP is that you can make penalty-free withdrawals from TESPHE (they are still taxable, just not subject to penalty) if you separate from service in the year you attain age 55 or older. This allows you to use TESPHE/SSIP for recurring withdrawals or a one-time penalty-free withdrawal. The rule is that the withdrawal must be made after you separate from service and have attained the age of 55. You can actually be 54 at the time of the withdrawal. Leon’s birthday is in December, but as long as he separated from Ford and made the withdrawal in the year he attained 55, no penalty. We sometimes recommend to retirees to leave some money in TESPHE/SSIP and do a partial withdrawal to maximize this provision.
If you’re interested in help with your IRA rollover, or have retirement or financial planning issues, LJPR is an independent, fee-only advisor that specializes in Ford retirements. Our staff includes experts in law, accounting, investment and financial planning. To schedule a complementary consultation, call 248-641-7400 or check out our website at http://www.LJPR.com.
Note: The forgoing information is provided by LJPR, LLC and represents the sole opinions of the authors. LJPR is an independent firm and does not work for, nor provide the official position of Ford, the UAW, or Fidelity Investments. The comparison in item 1 is a comparison of Fidelity Overseas mutual fund versus Julius Baer International (Load-Waived A share) as provided by Morningstar®, Inc. as of July 29, 2008. All information and tax rules are as of the beginning of September 2008.
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