You Can Move One Tax-Deferred Account To Another Without Tax Consequences
July 03, 2013

You Can Move One Tax-Deferred Account To Another Without Tax Consequences

Q. I am 67.  My wife is 66. We are both retired and receive about $65,000 a year in Social Security and pension payments. She has a 401(k) with her former employer worth about $216,000. Its return has been three to four percent, all in a "Stable Value" fund.  I have $420,000 in a 401(k) with my old employer. It is averaging a two to three percent per year return, also invested in a stable value fund.

In your columns you seem to suggest rolling over 401(k) accounts to an index fund or your Couch Potato portfolios for better returns. We feel better being conservative in our investments. They are our primary fallback sources of income. If we roll over the 401(k) accounts and invest in index funds, would we not have to pay taxes in the 25 to 35 percent range?

We will have to start minimum distributions at 70.5 years of age. It seems to me that I would have to average a return of 10 to 15 percent return on any new investments to recover the tax loss from the rollover. Am I missing something? What would be a prudent move for us at this point in our lives? —K.L., by email

A. The first thing you need to know is that when you do a rollover from a 401(k) account to an IRA rollover account there are NO tax consequences because you have moved from one tax-deferred plan to another tax-deferred plan. You may also be able to invest in an index fund without moving— just check the menu of choices in your existing plans. Index funds were rare choices ten years ago, but they are increasingly common today.

Some people can't bear the idea of every losing any money. You may be one of them. The only problem with your desire to avoid risk is that it commits you to accepting a return that will not be adequate for the long-term future that you face.

You and your wife have a joint life expectancy of about 25 years— one of you is likely to live that long. During that time you will be increasingly dependent on your savings. Basically you have a tough choice: you can steadily lose purchasing power to inflation or you can take some amount of risk and increase the probability that you'll have a return high enough to offset inflation.

Sometimes you can gain a great deal by taking a small amount of risk. The figures that follow come from Dimensional Fund Advisors. They show the long-term returns and risks of annual loss for different portfolios over the last 40 years:

  • If you invested 100 percent of your money in equities you would have lost money in six years and enjoyed a 40-year compound annual return of 13.2 percent.
  • If you invested 60 percent of your money in equities and 40 percent in fixed income, a traditional balanced fund, you would have lost money in six years and enjoyed a compound annual return of 10.9 percent.
  • If you invested 20 percent in equities and 80 percent in fixed income, you would have lost money in only one year and enjoyed a compound annual return of 8.2 percent.
  • If you invested 100 percent in fixed income you would never have lost money but your compound annual return would be only 6.8 percent.

As you can see, taking some amount of risk can increase your long-term returns significantly.

So what should you do? Put 20 percent in equities, in a low-cost index fund, and keep the remainder in fixed income. Your returns will increase nicely, you will have a small risk of loss, and you will have the sure knowledge that 80 percent of your money is relatively safe from loss.

Q. I will be 66 in July. I own my home. I owe about $116,000 and bought it for $204,000 four years ago. I have no children or other relatives to leave it to. What do you think of a reverse mortgage in my situation? —S.S., by email

A. A reverse mortgage won't work for you due to financing limits and expenses. Using an online calculator I found that you would not qualify for two of the three programs currently available. Under the third program you would qualify but would achieve no more than eliminating your current mortgage payment. This would be of some benefit. But without other resources it is likely that future expenses, taxes and insurance premiums would make you "house poor."

For the long term a better option would be to sell your home and become a renter, holding the equity you liberate as a reserve fund.

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This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.

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