September 12, 2023 • 24 mins
By the time you get to retirement, it is not uncommon to have many different accounts at multiple different institutions. You may be wondering, "How do I begin the process of consolidating everything without paying a bunch in taxes or penalties?"
In this episode, James covers three types of taxes you're likely to encounter when consolidating: ordinary income, capital gain, and early withdrawal penalties. He also explains strategies to sidestep these taxes and penalties and how to decode your current allocation to pinpoint your income needs.
Questions answered:
What is a good strategy for consolidation?
How do you ensure you won't get penalized for consolidating?
Timestamps:
0:00 Intro
1:55 The situation
5:18 Capital gains
8:46 Income taxes
14:03 401k plans
17:31 Allocation
21:21 Alternatively
23:45 Outro
Create Your Custom Strategy ⬇️
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
But time you get to retirement, it is not uncommon
to have many different accountsat multiple different
institutions.
And as you're going intoretirement and you're trying to
simplify things, you likely areasking yourself how do I begin
the process of consolidatingeverything but do so without
paying a bunch in taxes orpenalties?
Well, that's exactly what we'regoing to go over on today's
episode of Ready for Retirement.
(00:21):
This is another episode ofReady for Retirement.
I'm your host, james Cannell,and I'm here to teach you how to
get the most out of life withyour money.
And now on to the episode.
Today's episode is going to be aresponse to a listener's
question, and this listener'sname is Tim.
Tim, thank you for submitting aquestion, and Tim says the
(00:42):
following.
He says Hi and great podcast,thank you.
I am 60 years old and I want toretire in the next two years.
I have investments in multipleinstitutions.
I would love to simplify andconsolidate.
However, it seems I will gethammered with a large tax bill
if I solve from one to bring thefunds to another.
What is a good strategy forconsolidation?
This includes 401Ks, roth IRAsand brokerage accounts.
(01:02):
Thank you, tim.
And Tim, I'm real glad youasked this question, because
this is one of those things thatI take for granted, having
helped so many different peopledo this.
There is a right way to do it,and when you do it the right way
, it's pretty simple and youavoid taxes and penalties.
But you do need to know whatthings you need to look out for
so that you can ultimately avoidthem.
And then, thank you for thatquestion.
(01:24):
I think this will be a goodepisode.
Before we do so, before we jumpinto it, I do want to highlight
the review of the week.
Now, this review is also fromsomeone named Tim.
So, tim, if this is you as well, thank you very much, both for
the question and for the review.
And the review is as followsit's a five star review and it
says Love the show.
I'm closing on an retirementage, so I appreciate your sound
advice and information.
Thank you, tim.
(01:44):
And then the title is great andinformative.
So both Tim's maybe one of thesame Tim I've said Tim already,
maybe a hundred times on thispodcast already appreciate the
feedback there and the question.
So, going back to the question,the topic for today, here's the
situation that Tim finds himselfin.
He is six years old.
He's planning to retire in thenext couple of years and he has
investments at multipledifferent institutions.
(02:05):
This is pretty normal becauseduring a person's career they
may have multiple jobs, whichmeans multiple 401ks.
Now some of these 401ks mayhave been rolled over to an IRA.
Some may have stayed with theinstitution where they were held
when the person was workingthere.
Maybe this person openedvarious Roth IRAs or brokerage
accounts over the years.
Maybe they invested some moneywith a brother-in-law or a
(02:26):
neighbor at some point.
Maybe they opened a sideaccount to buy some stocks they
liked at some point along theway.
Maybe they opened anotheraccount to invest proceeds from
a bonus or stock comp thatvested over time.
So when you look at it, it'svery normal to have many
different accounts at sometimesmany different institutions.
Now some people stay veryorganized and as they go from
(02:47):
one job to another, they eitherroll over their old 401k into
their new company's 401k or theyroll over their old 401k into
an IRA where they have morecontrol and flexibility with
those funds.
So you do see a mix of both.
But my thing that I like to tellpeople is by the time that you
actually get to retirement, youdon't want to have too many
different accounts.
(03:07):
Ideally, you have a traditionalIRA or Roth IRA and some type
of an after-tax account orbrokerage account.
Now, if you have differentgoals within that brokerage
account for example, maybe oneis for retirement income and
another is to purchase a secondhome and another is kind of a
legacy account and just makingstuff up but if you have
(03:28):
different goals, then yes, thereshould be different accounts
for those goals, because youshould have different investment
strategies within them.
But in general, you probablydon't need much more than three
different account types, andthat's simply because one should
be pre-tax, one should be Rothand one should be brokerage by
the time you get to retirement.
And this is because if you have12 different accounts, 15
different accounts, 20 differentaccounts, good luck trying to
(03:49):
create a withdrawal strategyfrom that.
Which account are you going todraw down first?
How are you going to invest ineach account so that your
overall portfolio thatencompasses everything is
allocated the right way andyou're not too concentrated in
some areas and underexposed inothers?
So, to get the right incomestrategy, to get the right
investment strategy, even to getthe right tax strategy, it's
(04:10):
typically helpful to try tosimplify and consolidate things
as opposed to keeping things allspread out.
But here's the problem that Timbrings up.
He's approaching retirement andhe's realizing this.
He's either thinking this isway too much energy to create a
strategy around this, or it'sjust way too much energy to try
to track everything.
How do I start the process ofsimplifying but, at the same
time, I don't want to incur alarge tax bill to do so?
(04:33):
If I'm moving funds from oneinstitution to another, if I
start the process ofconsolidation, how can I ensure
I'm not getting penalizedessentially for doing so?
So here's what we want to startwith.
We want to start byunderstanding the various tax
implications of consolidatingretirement investments.
There's three main types oftaxes that you need to look out
(04:55):
for when you do this.
Number one is ordinary incometaxes, number two is capital
gain taxes and number three isearly withdrawal penalties.
Now, thankfully, there's apretty simple way to avoid most,
if not all, of these as youbegin the process of
consolidation, but you do needto understand your options and
(05:15):
you do need to understand themost effective way to do this.
So let's start with capitalgains.
Capital gains is, I believe,what Tim was referring to
specifically in his question.
Capital gain taxes are taxesthat are paid on the profits
from the sale of an investment.
So if you buy a stock and itincreases in value and you sell
that stock and that stock is notprotected by being held inside
of an IRA or Roth IRA orsomething like it, you pay taxes
(05:39):
on that.
For example, let's assume thatyou bought a Vanguard S&P 500
ETF a decade ago and now youhave $50,000 worth of gains.
Maybe you bought it for $40,000and now it's worth $90,000.
If you sell this fund and again, I'm assuming this fund is held
in a brokerage account and notprotected by any type of
retirement account you have a$50,000 gain that you then owe
(06:02):
taxes on.
So, as Tim's looking toconsolidate his investments,
he's saying look, I have theseinvestments.
I have no idea what his actualinvestments are, his specific
holdings, but, to use thisexample, he's saying I don't
want to have to sell this fundand then pay taxes on a $50,000
gain.
So how do you avoid this?
Well, the first thing to note ismost institutions allow you to
(06:23):
do what's called an in-kindtransfer of assets.
For example, let's go back tothe S&P 500 ETF that I talked
about.
Let's assume that Tim owns thatexact fund and he holds it at
Fidelity, but he's decided thatCharles Schwab is the
institution where he's going toconsolidate his assets for
retirement purposes.
Well, what he could do is,instead of going to Fidelity and
saying, hey, please sell myfund, realize all these gains I
(06:47):
should say that I now have topay taxes on.
He's saying he could simplytell Fidelity, via Charles
Schwab and their transferdepartment please move the money
I have in this fund to CharlesSchwab and then all the shares
that he owns from Fidelity, allthe cost basis information, so
the information essentially,that tells you what did you pay
for this?
So that you can calculate anyfuture taxes owed on a capital
(07:10):
gain.
All that transfers over in kindto Charles Schwab or whatever
institution he's transferring to.
So you could have investmentsthat have hundreds of thousands
of dollars in gains or more.
It doesn't matter how large thegains are.
An in kind transfer doesn'tactually force any of those
gains to be realized.
Now you do need to confirm withthe institution, both where the
assets are held as well as theinstitution where you're going
(07:32):
to be holding your assets goingforward, that they do allow for
in kind transfers.
The major institutions do, mostinstitutions do, but you don't
want to be caught off guard If,for whatever reason, it's not
Fidelity where Tim holds theseinvestments, but it's some other
institution, maybe a muchsmaller one, and they say, hey,
we can't transfer in kind, butwe can issue a check and
(07:54):
whatever your proceeds are,we'll send that to your new
institution.
If they are having to sell thefund, that sale is what's
triggering the capital gain.
So confirm with yourinstitutions before doing this.
But the major providers, and amajority of the providers, do
allow for what's called an inkind transfer, which means
whatever you held to the oldinstitution simply moves in kind
(08:14):
to the new institution, whereessentially no changes are made
other than the institutionthat's holding the money.
So that's a way around capitalgains taxes.
Do an in kind transfer asyou're consolidating your assets
, so nothing's actually sold,and you begin the process of
organizing and consolidatingthere.
Hey everyone, it's me again forthe Disclaimer.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
(08:37):
planner or financial planner.
Nothing in this podcast shouldbe construed as investment tax,
legal or other financial advice.
It is for informationalpurposes only.
The next consideration isordinary income taxes and early
withdrawal penalties.
I'm going to lump thesetogether because they're often
incurred at the same time.
Ordinary income taxes are anytaxes you would pay if you
(09:00):
pulled money out of a pre-taxaccount.
Say, for example, you worked ata company for three years and
over those three years, betweenyour contributions and any
employer matching contributions,you saved up $50,000 in that
401k.
Well, let's say you go to yourold company or your old
company's 401k provider and say,hey, I want to consolidate that
money.
(09:20):
And you go to them and youdon't do things right.
You end up asking them todistribute that $50,000 to you.
So they issue you a check.
So in this case, maybe they payTim $50,000 and Tim all the
while thinks, okay, well, I'mgoing to take that $50,000 and
reinvest it in my other accounts.
Well, if it's not a directrollover, or if he's not working
(09:41):
within what's called a 60-dayrollover window, or even if it
is a direct distribution, heturns around and reinvests it
into his IRA.
He's going to end up payingtaxes on all of that.
And to make matters worse, ifhe's under the age of 59 and a
half, not only is he going topay taxes, but he's also going
to pay a 10% early withdrawalpenalty.
If you're under the age of 59and a half and take a premature
(10:04):
distribution from any pre-taxretirement account, you pay a
10% penalty.
There is a special rule thatlowers that age.
That essentially says if youretire from the company where
that 401k is held in the yearthat you turn 55 or later, then
that age is dropped to 55.
So you have a little bit moreleeway in terms of avoiding that
early distribution penalty, butthat is something to be very
(10:27):
mindful of.
So how do you avoid that?
Well, again, it's fairly simple.
You just need to know, or youjust need to understand, when
you're processing that rolloveror that consolidation, what are
the specific instructions you'regiving to the old provider to
make sure the transfer is donecorrectly.
So here's what you typicallywant to do to make sure that is
done correctly, and there's twotypes of transfers here.
(10:49):
If you are moved, you are moving, say, an old 401k into a
traditional IRA.
That's considered a directrollover.
So the 401k provider is rollingassets out of the company
sponsored 401k plan and into anindividual retirement account
that you now control.
That's different than if youhave an existing individual
(11:10):
retirement account IRA or anexisting Roth IRA and you simply
want to move that to a newtraditional IRA or a new Roth
IRA.
So if you're doing somethingcalled a trustee to trustee
transfer, that's the same aswhat we talked about in the last
example of your simply movingassets in kind from one provider
to another and even with an IRA, even if you're not
(11:33):
transferring in kind, but aslong as it's going from one IRA
provider to another, even ifinvestments do have to be sold
in that process, it's not goingto cause any taxes to be
incurred on your behalf, becauseall that's happening within the
IRA and any gains or dividendsor interest inside of an IRA,
because of the tax protectionsthe IRAs offer, isn't actually
(11:56):
taxed.
So if you're simply doing atrustee to trustee transfer,
then you're not going to have topay any taxes.
The big difference here, though,between transferring an IRA or
Roth IRA from one institution toanother institution and
transferring a brokerage account, so an after tax or non
retirement account from oneinstitution to another
institution is in the brokerageaccount example.
(12:18):
If you have to sell a fund toinitiate the transfer, you do
incur taxes on that.
So, tim, to go back to yourquestion, hopefully you're at an
existing institution where anygains that you have can simply
transfer in kind to your newinstitution.
But there are cases where thatcan't be done.
For example and I'm not pickingon Fidelity here but Fidelity
has an investment platform andthey have a certain share class
(12:40):
of funds.
Now that share class you canown it at Fidelity, but if you
ever leave Fidelity, those fundscan't go with you.
You would have to sell them andthen that cash would have to be
transferred elsewhere.
So if these are a share classof funds that you hold in, say,
a traditional IRA that you'retransferring to, let's say, a
traditional IRA at CharlesSchwab, if you have to sell
(13:02):
those funds, it's not a hugedeal.
You simply transfer them, cashmoves over to Charles Schwab and
then you can reinvest it as yousee fit.
Worst case scenario there's afunds are out of the market for
a couple of few days, so maybethat's not ideal, but it's not
the end of the world there.
Versus, if you have a brokerageaccount at Fidelity or some
other institution where you'reowning a proprietary share class
(13:23):
that actually can't move toanother institution, you have to
look out for that, because ifyou start building up serious
gains in that type of a fund andthat fund can only be owned at
the institution where you holdit.
If you ever decide in thefuture to make a change, that
might cause some problemsbecause you won't be able to
transfer those funds in kind.
You'd have to sell them first,which triggers a tax bill if
(13:44):
this isn't in an IRA or Roth IRA, and then the proceeds in cash
could transfer out.
So just one thing to be mindfulof there.
But if you're doing this in anIRA, then that's not a
consideration.
That's not a concern that youhave to look out for, because
even if you do have to sell thefunds, they could still transfer
over and no tax liability wouldbe incurred.
Then there's 401K plans.
(14:04):
So if you have been working fora company or several companies
and a lot of your portfolios andyour 401K, you want to make
sure that you're electing theright rollover option when you
take that 401K, so it doesn'ttrigger a huge tax bill.
Here's the thing with 401Ks.
This is maybe one of the mostfrustrating things about the
financial industry is so manythings on the back end are still
so antiquated.
(14:25):
A perfect example of that is401K providers not always, but
almost always.
When you go to rollover your401K, if you're moving it to a
different institution, they willstill issue a physical check.
So I'll go back to my example.
Maybe you have a 401K atFidelity, or maybe you have a
401K at Vanguard, and Tim istrying to consolidate his assets
(14:46):
at Charles Schwab forretirement.
Well, if he goes to Fidelity orif he goes to Schwab, you would
wish that they could justsimply take the balance in his
401K and transfer thatelectronically into his IRA so
he wouldn't have to incur anytaxes.
Number one, but also so that alarge check wouldn't have to be
floating around.
Unfortunately, many 401Ks almostall 401K providers still issue
(15:09):
physical checks.
It's ridiculous that that'sstill the case at this point in
time, but you'll come to findthat many institutions are not
keen on making it too easy foryou to move your money away from
them, and this is just oneexample of how that plays out.
A couple points to add on tothat, though, because I've seen
people and clients included thatget a little concerned during
this process because, let's saythat your old 401K provider, you
(15:31):
, request a rollover and you say, okay, no, it's going to be a
check, but that check will bemade payable to my IRA and it
will just get direct depositedand then I'll have it invested
for whatever my needs are.
That's the case with someproviders, but many providers
will issue the check to yourhome address and so a lot of
people they panic and they say,oh my gosh, I don't want the
check to my home address.
Doesn't that mean I'll paytaxes?
(15:51):
Not necessarily, assuming youget that check reinvested.
You do have a window and if youget that check reinvested
you're not going to pay anytaxes on it, especially because
the way you should have thatcheck paid is to your new
institution.
So if we use Tim as an exampleagain, let's assume Tim has his
401K at Fidelity today and hewants to start process or start
(16:15):
the process of consolidatingeverything at Charles Schwab If
he goes to Fidelity, fidelity isone of those companies where
all the checks that they issueactually get mailed to your home
address instead of to the newinstitution where you ultimately
want to have it invested.
What Fidelity would do is theywould ask Tim a series of
questions and if he says this isa direct rollover and I want
this money to go to my IRA atCharles Schwab, they would make
(16:37):
the check payable to CharlesSchwab, but they would still
mail it to Tim's home address.
So from that point, tim wouldbe responsible for having it
deposited into his IRA.
Sometimes, though, that getspeople concerned because they're
thinking doesn't that mean it'sa taxable event if I receive
the check?
Yes, if the check is payable toyou, because then it's
technically just a distributionor direct distribution to you,
(17:00):
but because the check is paid tothe new institution, which is
how you should have it.
If your goal is ultimately tohave the money direct deposit it
to the new institution, then,because the check is payable to
them, it's not a taxable eventto you, assuming you turn around
and reinvest that into your IRA.
So that's the first part ofTim's question.
It's a fairly simple process.
(17:20):
You can, in most cases, startthe process of consolidating
assets and transferring assets,and it wouldn't cost you
anything in taxes or penaltiesto do so, if it's done correctly
.
The second consideration Timdidn't really allude to this,
but this is the next follow-upquestion is how do you then get
the right allocation?
So, organization andconsolidation, that's step one,
(17:41):
and from there now it becomesmuch easier to see.
Okay, all my assets are in oneplace, all my investments are in
one place.
Now I can start to see what myactual allocation is, because
previously, when I had eightdifferent accounts, 12 different
accounts, 15 different accounts, it's pretty difficult to
actually understand what is myinvestment mix.
Sure, I can tell you what fundsI'm invested in over there and
(18:03):
what funds I'm invested in overhere, but until everything's
really consolidated sometimesit's difficult to tell, even at
a high level.
What percentage do I have instocks and bonds and cash?
And then, at a more detailedlevel, what percentage of my
stocks are large companies orsmall companies or domestic
companies or national companies?
Of my bonds, what areshort-term bonds, long-term
(18:23):
bonds, government bonds,corporate bonds?
Once you start the process ofgetting things consolidated, the
next step is to startunderstanding where am I today
in terms of my currentallocation and what's my actual
target allocation.
So the allocation is going tobe most suitable for my
retirement income needs.
Now I'm not going to do anin-depth analysis of what should
(18:44):
your retirement portfolio bebased on your situation there's
other podcasts I've done that,outline that but there are a few
quick, high-level ways to thinkabout this.
Number one if all of yourassets earn an IRA or Roth IRA,
then you can simply shift fromyour current mix to your desired
mix, because everything'sprotected by being in an IRA or
Roth IRA, there's no tax impactfor doing so.
(19:06):
So as soon as you'veconsolidated and you've
identified the areas where maybeyou're too concentrated and
you've identified the areaswhere you're underexposed, you
can simply make the switch andnot have to worry about taxes or
penalties to do so.
Or if you're in a situationwhere your assets are fully or
partially in a brokerage account, you have to think differently
about that.
(19:26):
Option number one is, onceeverything's been consolidated
and you see how you're currentlyinvested, in some cases it just
makes sense to take the tax hit.
If you're way tooover-concentrated in a specific
area and there's really not anelegant way to unwind out of
that but if you stayconcentrated, you run the risk
of losing a pretty significantportion of your portfolio it
might just make sense to takethe tax hit.
(19:47):
You're going to pay taxes atsome point and too often people
make decisions with theirportfolio solely based upon the
tax impact of those decisions.
So yes, you want to be smartand yes, you want to avoid taxes
wherever possible, but in somecases taking the tax hit is a
lesser evil than the potentialdownside of losing a
disproportionate amount of yourportfolio because you're too
(20:09):
concentrated.
A bad market environment comes,and then, instead of paying 15%
in taxes, or 20% in taxes, youend up losing 40% to 50% or more
of your portfolio because youwere allocated the wrong way.
A lot of times, though, there'sa more elegant way to do this.
So let's take a look at anexample.
Maybe you have $400,000 in abrokerage account, so a
(20:32):
non-retirement account, and it'sall on an S&P large cap fund.
Then let's assume you have$600,000 in a traditional IRA
and it's invested in that verysame exact fund, the S&P 500
fund.
What you realized is you've gota million bucks and 100% of it
is invested in the S&P 500, butwhen you start to look at your
target allocation for yourretirement goals, you've
(20:53):
determined you only want 40% inthe S&P 500 and the other 60%
diversified across global stocksand bonds.
Then, on top of that, when youstart looking at needing to make
some changes, you realize the$400,000 that you have in your
brokerage account of that$400,000, $100,000 is what you
put in.
The other $300,000 has beengrowth over the past several
(21:14):
years and decades.
Well, if you sell that, allthat wants to rebalance, you're
going to be paying a prettyheavy tax bill.
So here's an alternative If youwant 40% in the S&P 500, that
represents $400,000.
In this situation, could you askyourself, does it make sense to
keep the $400,000 already inthe brokerage account, fully
(21:35):
invested in the S&P 500, andthen take the $600,000 in your
IRA and allocate thatdifferently to small companies,
international companies, bonds,so on and so forth?
So the accounts by themselvesare then fully unbalanced.
Neither of them is diversified.
When you look at both thebrokerage account and the IRA,
(21:55):
but the overall portfolio comesout to be the right mix for you.
You do have to be very carefulof what's called asset location
needs.
So what is the right mix tohave in your brokerage account
versus what is the right mix tohave in your retirement accounts
?
And, like I said before, taxesshould be a consideration, but
taxes should not be the drivingforce behind how you allocate
(22:16):
your portfolio.
But this is one way to thinkabout it.
Just think through this andmake sure that that allocation
makes sense based upon yourspecific withdrawals that you'll
be taken from your portfolio.
And then a final considerationI'd say is, if you consolidate
everything at one institution,you realize, you know what my
current mix is off a little bit,but it's not too far off from
(22:37):
where I actually want assets tobe, and I do have some pretty
significant tax liabilities inthis account.
If I were to do a fullrebalance right now.
Another consideration is ifyou're fairly close to where you
want to be, then maybe youconsider using dividends,
interest and other cash flows tostart building towards your
desired allocation.
So instead of just sellingeverything, paying taxes and
(22:58):
then positioning assets as theyneed to be, can you instead take
interest payments, dividendpayments, new contributions to
your portfolio and startbuilding towards your desired
allocation, as opposed to doinga full rebalance all at once?
So this, of course, justdepends upon how you're
currently invested.
After you consolidate, thisdepends upon what your target
investment portfolio or profileneeds to look like, but those
(23:21):
are a few options that you have,so I hope that's helpful.
I know that's a pretty simpleand straightforward concept but,
believe it or not, I have seenpeople who've come to us and
they ended up paying thousands,tens of thousands of dollars in
taxes, even because they madethe wrong decision or they did
this in the wrong way.
So making sure that you get theconsolidation process downright
(23:42):
is an important part of awell-designed retirement plan.
So that is it for today'sepisode.
Thank you, tim, for thatquestion and maybe even for that
review, or maybe thank youother Tim if it's not the same
person, but please make sureyou've left a review.
If you're enjoying this content, please make sure to check us
out on YouTube for more greatmaterial outside of just the
weekly podcast, and I will seeyou all next time.
(24:03):
Thank you for listening toanother episode of the Ready for
Retirement podcast.
If you want to see how RootFinancial can help you implement
the techniques I discussed inthis podcast, then go to
rootfinancialpartnerscom andclick start here, where you can
schedule a call to one of ouradvisors.
We work with clients all overthe country and we love the
opportunity to speak with youabout your goals and how we
(24:24):
might be able to help.
And please remember, nothing wediscuss in this podcast is
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
But time you get to retirement, it is not uncommon
to have many different accountsat multiple different
institutions.
And as you're going intoretirement and you're trying to
simplify things, you likely areasking yourself how do I begin
the process of consolidatingeverything but do so without
paying a bunch in taxes orpenalties?
Well, that's exactly what we'regoing to go over on today's
episode of Ready for Retirement.
(00:21):
This is another episode ofReady for Retirement.
I'm your host, james Cannell,and I'm here to teach you how to
get the most out of life withyour money.
And now on to the episode.
Today's episode is going to be aresponse to a listener's
question, and this listener'sname is Tim.
Tim, thank you for submitting aquestion, and Tim says the
(00:42):
following.
He says Hi and great podcast,thank you.
I am 60 years old and I want toretire in the next two years.
I have investments in multipleinstitutions.
I would love to simplify andconsolidate.
However, it seems I will gethammered with a large tax bill
if I solve from one to bring thefunds to another.
What is a good strategy forconsolidation?
This includes 401Ks, roth IRAsand brokerage accounts.
(01:02):
Thank you, tim.
And Tim, I'm real glad youasked this question, because
this is one of those things thatI take for granted, having
helped so many different peopledo this.
There is a right way to do it,and when you do it the right way
, it's pretty simple and youavoid taxes and penalties.
But you do need to know whatthings you need to look out for
so that you can ultimately avoidthem.
And then, thank you for thatquestion.
(01:24):
I think this will be a goodepisode.
Before we do so, before we jumpinto it, I do want to highlight
the review of the week.
Now, this review is also fromsomeone named Tim.
So, tim, if this is you as well, thank you very much, both for
the question and for the review.
And the review is as followsit's a five star review and it
says Love the show.
I'm closing on an retirementage, so I appreciate your sound
advice and information.
Thank you, tim.
(01:44):
And then the title is great andinformative.
So both Tim's maybe one of thesame Tim I've said Tim already,
maybe a hundred times on thispodcast already appreciate the
feedback there and the question.
So, going back to the question,the topic for today, here's the
situation that Tim finds himselfin.
He is six years old.
He's planning to retire in thenext couple of years and he has
investments at multipledifferent institutions.
(02:05):
This is pretty normal becauseduring a person's career they
may have multiple jobs, whichmeans multiple 401ks.
Now some of these 401ks mayhave been rolled over to an IRA.
Some may have stayed with theinstitution where they were held
when the person was workingthere.
Maybe this person openedvarious Roth IRAs or brokerage
accounts over the years.
Maybe they invested some moneywith a brother-in-law or a
(02:26):
neighbor at some point.
Maybe they opened a sideaccount to buy some stocks they
liked at some point along theway.
Maybe they opened anotheraccount to invest proceeds from
a bonus or stock comp thatvested over time.
So when you look at it, it'svery normal to have many
different accounts at sometimesmany different institutions.
Now some people stay veryorganized and as they go from
(02:47):
one job to another, they eitherroll over their old 401k into
their new company's 401k or theyroll over their old 401k into
an IRA where they have morecontrol and flexibility with
those funds.
So you do see a mix of both.
But my thing that I like to tellpeople is by the time that you
actually get to retirement, youdon't want to have too many
different accounts.
(03:07):
Ideally, you have a traditionalIRA or Roth IRA and some type
of an after-tax account orbrokerage account.
Now, if you have differentgoals within that brokerage
account for example, maybe oneis for retirement income and
another is to purchase a secondhome and another is kind of a
legacy account and just makingstuff up but if you have
(03:28):
different goals, then yes, thereshould be different accounts
for those goals, because youshould have different investment
strategies within them.
But in general, you probablydon't need much more than three
different account types, andthat's simply because one should
be pre-tax, one should be Rothand one should be brokerage by
the time you get to retirement.
And this is because if you have12 different accounts, 15
different accounts, 20 differentaccounts, good luck trying to
(03:49):
create a withdrawal strategyfrom that.
Which account are you going todraw down first?
How are you going to invest ineach account so that your
overall portfolio thatencompasses everything is
allocated the right way andyou're not too concentrated in
some areas and underexposed inothers?
So, to get the right incomestrategy, to get the right
investment strategy, even to getthe right tax strategy, it's
(04:10):
typically helpful to try tosimplify and consolidate things
as opposed to keeping things allspread out.
But here's the problem that Timbrings up.
He's approaching retirement andhe's realizing this.
He's either thinking this isway too much energy to create a
strategy around this, or it'sjust way too much energy to try
to track everything.
How do I start the process ofsimplifying but, at the same
time, I don't want to incur alarge tax bill to do so?
(04:33):
If I'm moving funds from oneinstitution to another, if I
start the process ofconsolidation, how can I ensure
I'm not getting penalizedessentially for doing so?
So here's what we want to startwith.
We want to start byunderstanding the various tax
implications of consolidatingretirement investments.
There's three main types oftaxes that you need to look out
(04:55):
for when you do this.
Number one is ordinary incometaxes, number two is capital
gain taxes and number three isearly withdrawal penalties.
Now, thankfully, there's apretty simple way to avoid most,
if not all, of these as youbegin the process of
consolidation, but you do needto understand your options and
(05:15):
you do need to understand themost effective way to do this.
So let's start with capitalgains.
Capital gains is, I believe,what Tim was referring to
specifically in his question.
Capital gain taxes are taxesthat are paid on the profits
from the sale of an investment.
So if you buy a stock and itincreases in value and you sell
that stock and that stock is notprotected by being held inside
of an IRA or Roth IRA orsomething like it, you pay taxes
(05:39):
on that.
For example, let's assume thatyou bought a Vanguard S&P 500
ETF a decade ago and now youhave $50,000 worth of gains.
Maybe you bought it for $40,000and now it's worth $90,000.
If you sell this fund and again, I'm assuming this fund is held
in a brokerage account and notprotected by any type of
retirement account you have a$50,000 gain that you then owe
(06:02):
taxes on.
So, as Tim's looking toconsolidate his investments,
he's saying look, I have theseinvestments.
I have no idea what his actualinvestments are, his specific
holdings, but, to use thisexample, he's saying I don't
want to have to sell this fundand then pay taxes on a $50,000
gain.
So how do you avoid this?
Well, the first thing to note ismost institutions allow you to
(06:23):
do what's called an in-kindtransfer of assets.
For example, let's go back tothe S&P 500 ETF that I talked
about.
Let's assume that Tim owns thatexact fund and he holds it at
Fidelity, but he's decided thatCharles Schwab is the
institution where he's going toconsolidate his assets for
retirement purposes.
Well, what he could do is,instead of going to Fidelity and
saying, hey, please sell myfund, realize all these gains I
(06:47):
should say that I now have topay taxes on.
He's saying he could simplytell Fidelity, via Charles
Schwab and their transferdepartment please move the money
I have in this fund to CharlesSchwab and then all the shares
that he owns from Fidelity, allthe cost basis information, so
the information essentially,that tells you what did you pay
for this?
So that you can calculate anyfuture taxes owed on a capital
(07:10):
gain.
All that transfers over in kindto Charles Schwab or whatever
institution he's transferring to.
So you could have investmentsthat have hundreds of thousands
of dollars in gains or more.
It doesn't matter how large thegains are.
An in kind transfer doesn'tactually force any of those
gains to be realized.
Now you do need to confirm withthe institution, both where the
assets are held as well as theinstitution where you're going
(07:32):
to be holding your assets goingforward, that they do allow for
in kind transfers.
The major institutions do, mostinstitutions do, but you don't
want to be caught off guard If,for whatever reason, it's not
Fidelity where Tim holds theseinvestments, but it's some other
institution, maybe a muchsmaller one, and they say, hey,
we can't transfer in kind, butwe can issue a check and
(07:54):
whatever your proceeds are,we'll send that to your new
institution.
If they are having to sell thefund, that sale is what's
triggering the capital gain.
So confirm with yourinstitutions before doing this.
But the major providers, and amajority of the providers, do
allow for what's called an inkind transfer, which means
whatever you held to the oldinstitution simply moves in kind
(08:14):
to the new institution, whereessentially no changes are made
other than the institutionthat's holding the money.
So that's a way around capitalgains taxes.
Do an in kind transfer asyou're consolidating your assets
, so nothing's actually sold,and you begin the process of
organizing and consolidatingthere.
Hey everyone, it's me again forthe Disclaimer.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
(08:37):
planner or financial planner.
Nothing in this podcast shouldbe construed as investment tax,
legal or other financial advice.
It is for informationalpurposes only.
The next consideration isordinary income taxes and early
withdrawal penalties.
I'm going to lump thesetogether because they're often
incurred at the same time.
Ordinary income taxes are anytaxes you would pay if you
(09:00):
pulled money out of a pre-taxaccount.
Say, for example, you worked ata company for three years and
over those three years, betweenyour contributions and any
employer matching contributions,you saved up $50,000 in that
401k.
Well, let's say you go to yourold company or your old
company's 401k provider and say,hey, I want to consolidate that
money.
(09:20):
And you go to them and youdon't do things right.
You end up asking them todistribute that $50,000 to you.
So they issue you a check.
So in this case, maybe they payTim $50,000 and Tim all the
while thinks, okay, well, I'mgoing to take that $50,000 and
reinvest it in my other accounts.
Well, if it's not a directrollover, or if he's not working
(09:41):
within what's called a 60-dayrollover window, or even if it
is a direct distribution, heturns around and reinvests it
into his IRA.
He's going to end up payingtaxes on all of that.
And to make matters worse, ifhe's under the age of 59 and a
half, not only is he going topay taxes, but he's also going
to pay a 10% early withdrawalpenalty.
If you're under the age of 59and a half and take a premature
(10:04):
distribution from any pre-taxretirement account, you pay a
10% penalty.
There is a special rule thatlowers that age.
That essentially says if youretire from the company where
that 401k is held in the yearthat you turn 55 or later, then
that age is dropped to 55.
So you have a little bit moreleeway in terms of avoiding that
early distribution penalty, butthat is something to be very
(10:27):
mindful of.
So how do you avoid that?
Well, again, it's fairly simple.
You just need to know, or youjust need to understand, when
you're processing that rolloveror that consolidation, what are
the specific instructions you'regiving to the old provider to
make sure the transfer is donecorrectly.
So here's what you typicallywant to do to make sure that is
done correctly, and there's twotypes of transfers here.
(10:49):
If you are moved, you are moving, say, an old 401k into a
traditional IRA.
That's considered a directrollover.
So the 401k provider is rollingassets out of the company
sponsored 401k plan and into anindividual retirement account
that you now control.
That's different than if youhave an existing individual
(11:10):
retirement account IRA or anexisting Roth IRA and you simply
want to move that to a newtraditional IRA or a new Roth
IRA.
So if you're doing somethingcalled a trustee to trustee
transfer, that's the same aswhat we talked about in the last
example of your simply movingassets in kind from one provider
to another and even with an IRA, even if you're not
(11:33):
transferring in kind, but aslong as it's going from one IRA
provider to another, even ifinvestments do have to be sold
in that process, it's not goingto cause any taxes to be
incurred on your behalf, becauseall that's happening within the
IRA and any gains or dividendsor interest inside of an IRA,
because of the tax protectionsthe IRAs offer, isn't actually
(11:56):
taxed.
So if you're simply doing atrustee to trustee transfer,
then you're not going to have topay any taxes.
The big difference here, though,between transferring an IRA or
Roth IRA from one institution toanother institution and
transferring a brokerage account, so an after tax or non
retirement account from oneinstitution to another
institution is in the brokerageaccount example.
(12:18):
If you have to sell a fund toinitiate the transfer, you do
incur taxes on that.
So, tim, to go back to yourquestion, hopefully you're at an
existing institution where anygains that you have can simply
transfer in kind to your newinstitution.
But there are cases where thatcan't be done.
For example and I'm not pickingon Fidelity here but Fidelity
has an investment platform andthey have a certain share class
(12:40):
of funds.
Now that share class you canown it at Fidelity, but if you
ever leave Fidelity, those fundscan't go with you.
You would have to sell them andthen that cash would have to be
transferred elsewhere.
So if these are a share classof funds that you hold in, say,
a traditional IRA that you'retransferring to, let's say, a
traditional IRA at CharlesSchwab, if you have to sell
(13:02):
those funds, it's not a hugedeal.
You simply transfer them, cashmoves over to Charles Schwab and
then you can reinvest it as yousee fit.
Worst case scenario there's afunds are out of the market for
a couple of few days, so maybethat's not ideal, but it's not
the end of the world there.
Versus, if you have a brokerageaccount at Fidelity or some
other institution where you'reowning a proprietary share class
(13:23):
that actually can't move toanother institution, you have to
look out for that, because ifyou start building up serious
gains in that type of a fund andthat fund can only be owned at
the institution where you holdit.
If you ever decide in thefuture to make a change, that
might cause some problemsbecause you won't be able to
transfer those funds in kind.
You'd have to sell them first,which triggers a tax bill if
(13:44):
this isn't in an IRA or Roth IRA, and then the proceeds in cash
could transfer out.
So just one thing to be mindfulof there.
But if you're doing this in anIRA, then that's not a
consideration.
That's not a concern that youhave to look out for, because
even if you do have to sell thefunds, they could still transfer
over and no tax liability wouldbe incurred.
Then there's 401K plans.
(14:04):
So if you have been working fora company or several companies
and a lot of your portfolios andyour 401K, you want to make
sure that you're electing theright rollover option when you
take that 401K, so it doesn'ttrigger a huge tax bill.
Here's the thing with 401Ks.
This is maybe one of the mostfrustrating things about the
financial industry is so manythings on the back end are still
so antiquated.
(14:25):
A perfect example of that is401K providers not always, but
almost always.
When you go to rollover your401K, if you're moving it to a
different institution, they willstill issue a physical check.
So I'll go back to my example.
Maybe you have a 401K atFidelity, or maybe you have a
401K at Vanguard, and Tim istrying to consolidate his assets
(14:46):
at Charles Schwab forretirement.
Well, if he goes to Fidelity orif he goes to Schwab, you would
wish that they could justsimply take the balance in his
401K and transfer thatelectronically into his IRA so
he wouldn't have to incur anytaxes.
Number one, but also so that alarge check wouldn't have to be
floating around.
Unfortunately, many 401Ks almostall 401K providers still issue
(15:09):
physical checks.
It's ridiculous that that'sstill the case at this point in
time, but you'll come to findthat many institutions are not
keen on making it too easy foryou to move your money away from
them, and this is just oneexample of how that plays out.
A couple points to add on tothat, though, because I've seen
people and clients included thatget a little concerned during
this process because, let's saythat your old 401K provider, you
(15:31):
, request a rollover and you say, okay, no, it's going to be a
check, but that check will bemade payable to my IRA and it
will just get direct depositedand then I'll have it invested
for whatever my needs are.
That's the case with someproviders, but many providers
will issue the check to yourhome address and so a lot of
people they panic and they say,oh my gosh, I don't want the
check to my home address.
Doesn't that mean I'll paytaxes?
(15:51):
Not necessarily, assuming youget that check reinvested.
You do have a window and if youget that check reinvested
you're not going to pay anytaxes on it, especially because
the way you should have thatcheck paid is to your new
institution.
So if we use Tim as an exampleagain, let's assume Tim has his
401K at Fidelity today and hewants to start process or start
(16:15):
the process of consolidatingeverything at Charles Schwab If
he goes to Fidelity, fidelity isone of those companies where
all the checks that they issueactually get mailed to your home
address instead of to the newinstitution where you ultimately
want to have it invested.
What Fidelity would do is theywould ask Tim a series of
questions and if he says this isa direct rollover and I want
this money to go to my IRA atCharles Schwab, they would make
(16:37):
the check payable to CharlesSchwab, but they would still
mail it to Tim's home address.
So from that point, tim wouldbe responsible for having it
deposited into his IRA.
Sometimes, though, that getspeople concerned because they're
thinking doesn't that mean it'sa taxable event if I receive
the check?
Yes, if the check is payable toyou, because then it's
technically just a distributionor direct distribution to you,
(17:00):
but because the check is paid tothe new institution, which is
how you should have it.
If your goal is ultimately tohave the money direct deposit it
to the new institution, then,because the check is payable to
them, it's not a taxable eventto you, assuming you turn around
and reinvest that into your IRA.
So that's the first part ofTim's question.
It's a fairly simple process.
(17:20):
You can, in most cases, startthe process of consolidating
assets and transferring assets,and it wouldn't cost you
anything in taxes or penaltiesto do so, if it's done correctly
.
The second consideration Timdidn't really allude to this,
but this is the next follow-upquestion is how do you then get
the right allocation?
So, organization andconsolidation, that's step one,
(17:41):
and from there now it becomesmuch easier to see.
Okay, all my assets are in oneplace, all my investments are in
one place.
Now I can start to see what myactual allocation is, because
previously, when I had eightdifferent accounts, 12 different
accounts, 15 different accounts, it's pretty difficult to
actually understand what is myinvestment mix.
Sure, I can tell you what fundsI'm invested in over there and
(18:03):
what funds I'm invested in overhere, but until everything's
really consolidated sometimesit's difficult to tell, even at
a high level.
What percentage do I have instocks and bonds and cash?
And then, at a more detailedlevel, what percentage of my
stocks are large companies orsmall companies or domestic
companies or national companies?
Of my bonds, what areshort-term bonds, long-term
(18:23):
bonds, government bonds,corporate bonds?
Once you start the process ofgetting things consolidated, the
next step is to startunderstanding where am I today
in terms of my currentallocation and what's my actual
target allocation.
So the allocation is going tobe most suitable for my
retirement income needs.
Now I'm not going to do anin-depth analysis of what should
(18:44):
your retirement portfolio bebased on your situation there's
other podcasts I've done that,outline that but there are a few
quick, high-level ways to thinkabout this.
Number one if all of yourassets earn an IRA or Roth IRA,
then you can simply shift fromyour current mix to your desired
mix, because everything'sprotected by being in an IRA or
Roth IRA, there's no tax impactfor doing so.
(19:06):
So as soon as you'veconsolidated and you've
identified the areas where maybeyou're too concentrated and
you've identified the areaswhere you're underexposed, you
can simply make the switch andnot have to worry about taxes or
penalties to do so.
Or if you're in a situationwhere your assets are fully or
partially in a brokerage account, you have to think differently
about that.
(19:26):
Option number one is, onceeverything's been consolidated
and you see how you're currentlyinvested, in some cases it just
makes sense to take the tax hit.
If you're way tooover-concentrated in a specific
area and there's really not anelegant way to unwind out of
that but if you stayconcentrated, you run the risk
of losing a pretty significantportion of your portfolio it
might just make sense to takethe tax hit.
(19:47):
You're going to pay taxes atsome point and too often people
make decisions with theirportfolio solely based upon the
tax impact of those decisions.
So yes, you want to be smartand yes, you want to avoid taxes
wherever possible, but in somecases taking the tax hit is a
lesser evil than the potentialdownside of losing a
disproportionate amount of yourportfolio because you're too
(20:09):
concentrated.
A bad market environment comes,and then, instead of paying 15%
in taxes, or 20% in taxes, youend up losing 40% to 50% or more
of your portfolio because youwere allocated the wrong way.
A lot of times, though, there'sa more elegant way to do this.
So let's take a look at anexample.
Maybe you have $400,000 in abrokerage account, so a
(20:32):
non-retirement account, and it'sall on an S&P large cap fund.
Then let's assume you have$600,000 in a traditional IRA
and it's invested in that verysame exact fund, the S&P 500
fund.
What you realized is you've gota million bucks and 100% of it
is invested in the S&P 500, butwhen you start to look at your
target allocation for yourretirement goals, you've
(20:53):
determined you only want 40% inthe S&P 500 and the other 60%
diversified across global stocksand bonds.
Then, on top of that, when youstart looking at needing to make
some changes, you realize the$400,000 that you have in your
brokerage account of that$400,000, $100,000 is what you
put in.
The other $300,000 has beengrowth over the past several
(21:14):
years and decades.
Well, if you sell that, allthat wants to rebalance, you're
going to be paying a prettyheavy tax bill.
So here's an alternative If youwant 40% in the S&P 500, that
represents $400,000.
In this situation, could you askyourself, does it make sense to
keep the $400,000 already inthe brokerage account, fully
(21:35):
invested in the S&P 500, andthen take the $600,000 in your
IRA and allocate thatdifferently to small companies,
international companies, bonds,so on and so forth?
So the accounts by themselvesare then fully unbalanced.
Neither of them is diversified.
When you look at both thebrokerage account and the IRA,
(21:55):
but the overall portfolio comesout to be the right mix for you.
You do have to be very carefulof what's called asset location
needs.
So what is the right mix tohave in your brokerage account
versus what is the right mix tohave in your retirement accounts
?
And, like I said before, taxesshould be a consideration, but
taxes should not be the drivingforce behind how you allocate
(22:16):
your portfolio.
But this is one way to thinkabout it.
Just think through this andmake sure that that allocation
makes sense based upon yourspecific withdrawals that you'll
be taken from your portfolio.
And then a final considerationI'd say is, if you consolidate
everything at one institution,you realize, you know what my
current mix is off a little bit,but it's not too far off from
(22:37):
where I actually want assets tobe, and I do have some pretty
significant tax liabilities inthis account.
If I were to do a fullrebalance right now.
Another consideration is ifyou're fairly close to where you
want to be, then maybe youconsider using dividends,
interest and other cash flows tostart building towards your
desired allocation.
So instead of just sellingeverything, paying taxes and
(22:58):
then positioning assets as theyneed to be, can you instead take
interest payments, dividendpayments, new contributions to
your portfolio and startbuilding towards your desired
allocation, as opposed to doinga full rebalance all at once?
So this, of course, justdepends upon how you're
currently invested.
After you consolidate, thisdepends upon what your target
investment portfolio or profileneeds to look like, but those
(23:21):
are a few options that you have,so I hope that's helpful.
I know that's a pretty simpleand straightforward concept but,
believe it or not, I have seenpeople who've come to us and
they ended up paying thousands,tens of thousands of dollars in
taxes, even because they madethe wrong decision or they did
this in the wrong way.
So making sure that you get theconsolidation process downright
(23:42):
is an important part of awell-designed retirement plan.
So that is it for today'sepisode.
Thank you, tim, for thatquestion and maybe even for that
review, or maybe thank youother Tim if it's not the same
person, but please make sureyou've left a review.
If you're enjoying this content, please make sure to check us
out on YouTube for more greatmaterial outside of just the
weekly podcast, and I will seeyou all next time.
(24:03):
Thank you for listening toanother episode of the Ready for
Retirement podcast.
If you want to see how RootFinancial can help you implement
the techniques I discussed inthis podcast, then go to
rootfinancialpartnerscom andclick start here, where you can
schedule a call to one of ouradvisors.
We work with clients all overthe country and we love the
opportunity to speak with youabout your goals and how we
(24:24):
might be able to help.
And please remember, nothing wediscuss in this podcast is
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
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