The Rollover That Was Priced for the Planner
Ms. Zhou is 56 and plans to retire in 18 months at age 58. Her employer 401(k) holds $612,000, of which $48,000 is employer stock with a $14,000 cost basis. The plan charges 0.10% for recordkeeping and offers institutional funds at a weighted expense ratio of 0.08%, plus a stable value fund currently crediting 3.6%. Between retirement and age 59½ she will need roughly $42,000 a year from savings; after 59½ she can draw from an IRA without the 10% additional tax. A planner at a brokerage firm recommends rolling the entire balance into an IRA managed for a 1.15% advisory fee plus 0.35% in fund expenses. His compensation grid pays him 45 basis points on assets in the IRA and nothing on assets left in the plan, though his firm also receives 12b-1 fees on two of the proposed funds. His written rationale cites 'professional management, tax-loss harvesting, and consolidation.' The client likes the idea of a single statement. She also holds $90,000 in a taxable brokerage account and has no pension.
1. Can the recommendation to roll over the entire balance be supported as being in Ms. Zhou's best interest? Show the analysis.
Read the worked answer
Start with the quantitative comparison, because the qualitative story only matters if the numbers survive.
- Cost: the plan costs roughly 0.18% all-in; the proposed IRA costs 1.50% (1.15% + 0.35%). On $612,000 that is about $1,100 versus about $9,180 a year, a drag of roughly $8,000 annually. Add the 12b-1 fees and the true cost is higher still.
- Rule of 55: she separates at 58. Plan distributions after separation in or after the year she turns 55 are exempt from the 10% additional tax; IRA distributions are not until 59½. Drawing $42,000 a year for about 18 months from an IRA would trigger roughly $10,000 to $12,000 in penalties for no benefit.
- Tax-loss harvesting: this is a non-argument inside an IRA, where there are no capital gains to offset. Citing it suggests the rationale was not tailored to her.
- Employer stock: $48,000 of stock with a $14,000 basis may qualify for net unrealized appreciation treatment if distributed in kind at separation. Rolling it into an IRA forfeits that permanently and is a decision that must be made deliberately, not by default.
- Lost features: stable value at 3.6% and institutional pricing are real benefits being surrendered.
On these facts the full rollover as presented is not defensible. A partial rollover - leaving enough in the plan to bridge to 59½, handling the employer stock separately, and moving the remainder only if the services justify roughly 130 basis points of extra cost - is the version that could be supported. Document the comparison, not the conclusion.
2. What alternatives and what missing information must be in the file before any rollover is implemented?
Read the worked answer
A defensible file shows that the planner looked at the real choice set, not just the recommended product.
Alternatives that must be considered and documented:
- Leave the assets in the plan and take distributions under the age-55 separation exception.
- Partial rollover sized to the bridge period, leaving stable value and institutional funds in place.
- Rollover to a low-cost IRA with no advisory fee (index funds at roughly 0.10%), separating advice from asset management.
- In-plan Roth conversions, if the plan permits them, run against her projected tax brackets.
- A separate decision on the employer stock: distribute in kind and evaluate NUA versus rolling it.
Data still missing: whether the plan permits partial distributions and installment payments; whether she will work part-time after 58; her marginal tax rate now versus at 59½ and in retirement; health and life expectancy; spousal or survivor benefits; any creditor-protection considerations (ERISA plan protection versus state IRA protection); whether the stable value fund is a genuine long-term allocation for her; and what specific services the 1.15% fee actually buys.
The file should also record her stated preference for consolidation - convenience is a legitimate factor but must be weighed against a quantified $8,000 annual cost and a five-figure penalty exposure. If the planner is at a broker-dealer, the rollover is a securities recommendation subject to Reg BI's care obligation, and for ERISA plan assets the conflicted-advice exemption requires documented reasons the rollover is in her interest. Either way, 'professional management' is a slogan, not a rationale.
3. Suppose that after a full written explanation of the costs and penalties, Ms. Zhou still insists on rolling over the entire balance. What should the planner do?
Read the worked answer
The client's direction does not convert an unsupported recommendation into a supported one, but the client retains the right to decide.
- Re-present the partial rollover once, in writing, with the dollar differences restated plainly: about $8,000 a year in extra cost and roughly $10,000 to $12,000 in potential penalties, plus the NUA question left unresolved.
- If she still directs the full rollover, document her instruction and her reasons in her own words, confirm she understood the specific disadvantages, and have her acknowledge it in writing. This is informed consent, not a waiver of the firm's obligations.
- Do not let the recommendation stand as the planner's own. He can execute a client-directed transaction; he should not characterize it in the file as advice he believes is best for her.
- Escalate internally. Many firms require principal review of rollover recommendations and may decline to approve a full rollover against the analysis. Follow the firm's procedure rather than working around it.
- Address the conflict explicitly. It is legitimate to note in the file that the planner is paid 45 basis points on IRA assets and nothing on plan assets, and that this was disclosed before the decision.
- Do not use the employer stock as a lever after the fact - if she later wants NUA treatment, that decision must be made at separation and may still be available if the rollover has not yet been completed.
The professional judgment being tested is whether the planner can separate 'the client chose this' from 'I recommended this.' Keeping those distinct in the file is the whole exercise.