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Rollovers and Prohibited Transactions: What Investors Need to Know

Rollovers and Prohibited Transactions: What Investors Need to Know

| June 01, 2022

If you've left an employer and are considering moving your 401(k) retirement savings to another plan or an IRA, there is new legislation on these transactions you should know. On December 18, 2020, the Department of Labor (DOL) adopted Prohibited Transaction Exemption (PTE) 2020-02, Improving Investment Advice for Workers & Retirees, covering prohibited transactions resulting from both rollover advice and advice on how to invest assets within a plan or IRA. Here is what investors need to know about how PTE 2020-02 will impact rollovers starting this summer.

Understanding Prohibited Transaction Exemption (PTE) 2020-02

Starting February 1st, 2022, investment advice fiduciaries “who are working diligently and in good faith" must comply with the DOL’s impartial conduct standards as it relates to PTE 2020-02. The legislation covers how financial professionals demonstrate that the rollover advice they provide to retirement plan participants and IRA customers is in the customers' best interest if the advisors want to receive compensation. The rule includes commissions, 12b-1 fees, revenue sharing, and markups and markdowns in certain principal transactions.

While financial professionals and retirement plan sponsors welcome this legislation, it will require implementing reliable solutions for training professionals, software to process the comparative cost information, updating compliance software, and other documentation processes that the DOL requires under this new rule.

Fiduciary standards for financial professionals require that they demonstrate to their clients that the rollover is in their best interest. PTE 2020-02 will require more documentation, internal and external processes, and paperwork to prove the fiduciary standards are satisfied before processing a rollover

PTE grace period

The DOL has initiated February 1st through June 30th, 2022, as a 'grace period' for financial professionals to continue processing rollovers for investors wishing to move their 401(k) assets into another plan or IRA ahead of the June 30th, 2022 deadline and new documentation requirements.

Who is impacted by the PTE 2020-02 rule?

  • Retirement plan participants (investors)

  • Beneficiaries

  • IRAs (custodians)

  • IRA owners

  • Retirement plan sponsors

  • Financial professionals

Retirement plan rollover options

A plan participant leaving an employer's retirement savings plan typically has four options and may engage in a combination of any of these options. Each choice offers advantages and disadvantages to consider, outlined here:

Option #1- Leave the 401(k) in the former employer's plan- If permitted by the retirement plan, a former employee can choose to leave their 401(k) in the plan when they terminate employment. If you consider this option, your HR department or retirement plan administrator is an excellent place to start seeing if this option is available.

Option #2- 401(k) portability- Rolling a 401(k) into another employer's plan is possible if the new plan accepts rollovers from another 401(k) plan. This option may make it easier for you to track the performance of your assets, but be sure to evaluate your new employer's plan by examining the investment choices and fees first.

Option #3- Rollover your 401(k) assets into an IRA- You have a few options with a direct rollover:

  • 401(k) into an IRA- You can roll over your 401(k) into your existing IRA or open a new IRA and initiate a custodian to custodian transfer. Remember that if you receive a check from the 401(k) plan's custodian, you have thirty days from the date of the check to send it to the IRA custodian, or the IRS may treat it as an early distribution which is subject to taxes, and if you're younger than age 59 1/2, a 10% penalty.
  • 401(k) Roth into a Roth IRA- You can roll your 401(k), Roth, into an existing Roth IRA or open a new one. No taxes are due when the assets are transferred and any new earnings accumulate tax-deferred. Earnings are eligible for tax-free withdrawal once the IRA has been open at least five years and you are at least age 59 1/2.
  • 401(k) into a Roth IRA- If your 401(k) plan permits rollovers into a Roth IRA, you can initiate the rollover into your Roth IRA or open a new one. Be aware that you will need to pay taxes on this type of rollover transfer, so it's essential you consult your financial and tax professionals before choosing this transfer option.

Earnings on the Roth IRA that accumulate after the rollover will be eligible for tax-free withdrawal when the IRA has been open for at least five years and you are age 59 1/2 or older. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax.

Option #4- Cash out the 401(k)- Cashing out a 401(k) is a taxable event since the contributions and accumulation are taxable, regardless of the employee's age. Also, if you're younger than age 59 1/2, you will pay a 10% penalty. The IRS allows penalty-free withdrawals from retirement accounts after age 59 1/2 and requires withdrawals after age 72 (Required Minimum Distributions, or RMDs). There are some exceptions to these rules for 401ks and other qualified plans, so it's essential you consult your plan administrator.


Important Disclosures
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by Fresh Finance.
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