Bad Advice Turns Me Into the Hulk
Before he transformed into the Incredible Hulk, Bruce Banner once said to his antagonist, “Don’t make me angry. You wouldn’t like me when I’m angry.” That’s a little how I feel when I hear stories about lazy financial professionals giving bad advice. Not that I’m about to turn green and rip through my clothes, but I do feel my blood start to boil.
A member of Ed Slott Elite IRA Advisor GroupSM (Elite Advisor) called me the other day with a frustrating story. He met a relatively young widow (age 55) and they discussed her financial situation. Her husband recently passed away, leaving his 401(k) valued at around $1 million. Another less experienced advisor had the widow move the 401(k) into an IRA in her name via spousal rollover. This is a perfectly acceptable transaction, but it was definitively the WRONG advice in this case. Why?
The Elite Advisor learned that the young widow needed some of the $1 million for daily living expenses. However, doing a spousal rollover eliminated her ability to withdraw from the IRA without a 10% early distribution penalty. Unfortunately, once a spousal rollover is completed, there is no going back. There is no transaction available to reverse what had been done. Adding to the misery, the other advisor told the widow that if she chose any other option, she would be forced to withdraw all $1 million within 10 years.
The Elite Advisor knew this was false. Just plain wrong. When he called to share the story and to see if there was a path forward…that’s when the Hulk inside me began to stir.
What was the proper guidance in this situation? Instead of doing a spousal rollover, the young widow could have established an inherited IRA. With an inherited IRA, all distributions avoid the 10% early withdrawal penalty. Yes, these distributions are taxable, but the widow would have had total access to all $1 million, free and clear of any penalty. Additionally, there would be no annual required minimum distributions (RMDs) from this account. Spouse beneficiaries are allowed to delay RMDs on an inherited IRA until the deceased spouse would have been RMD age. Finally, when the widow turned age 59½ in a few years, she could have then done a spousal rollover. There is no deadline to do a spousal rollover after first electing an inherited IRA. Since the widow would be over age 59½, the 10% early withdrawal penalty would no longer apply, so she could then move the inherited IRA into her own name.
Frustrated by the actions of a less knowledgeable professional, the Elite Advisor and I put our heads together. There was no unwinding the spousal rollover. There was no other 10% penalty exception to which the widow could qualify. The “emergency expense” exception ($1,000) would not be enough to meet her monetary needs. So, as the only option, the decision was made to implement a 72(t) substantially equal periodic payment program.
The Elite Advisor will properly install the payment program by splitting the IRA and leveraging the highest possible interest rate…but that is another story. For now, the young widow is in good hands. Recognize that not all financial professionals are created equally. Some are superheroes, here to serve, with superior training, experience and knowledge. Seek them out.
By Andy Ives, CFP®, AIF®
IRA Analyst
Ed Slott and Company, LLC
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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.