IRA Rollover

In this article, we're going to discuss IRA rollovers.  We'll start off by briefly discussing why an IRA rollover might be necessary, as well as provide you with a definition of the term.  We're then going to explain the difference between a rollover and a transfer, and finish up with some of the rollover rules you need to be aware of to avoid income tax penalties.

What is an IRA Rollover?

Lifetime employment is an outdated concept.  That being said, there are two future mindsets you can be certain of:

• You'll reach a point where retirement planning becomes a priority.
• There is a good chance that you will not finish your career with the same employer that you started your career with.

Some companies will allow you to keep your retirement savings in their plan's account until you reach retirement age, even if you leave the company.  But, there is a very good chance you'll lose some flexibility in how that money is invested after you leave.  The account might go from one that can be actively managed, to one that is "frozen" with respect to the allocation of funds between asset types.

You may also wish to consolidate your retirement plans, so that you don't need to worry about managing several accounts.  If that's true, then one day you may need to make a decision concerning an IRA rollover.

IRA Rollover Defined

An IRA rollover is a tax-free distribution from one retirement account that is contributed to an IRA.  There are several kinds of retirement accounts that can be rolled-over into a traditional IRA, including another traditional IRA, an employer's qualified plan such as a 401(k) plan, deferred compensation plans (section 457 plan), and a tax-sheltered annuity plan such as a 403(b).

You should always check with your plan administrator to make sure you can take a rollover from your account.

IRA Rollovers versus Transfers

There are two ways of moving money between financial institutions:  performing a transfer, or doing a rollover.  Most of the time, it is far easier to do a transfer than a rollover, especially if your existing plan will accommodate the request.

With a transfer, you would make arrangements with another financial institution to receive funds from your current institution.  The receiving institution then sends a request to the disbursing institution requesting a transfer of funds.  This is usually accomplished via a physical check.

This type of transaction does not have to be reported to the IRS, and requires very little work on behalf of the account holder's part.  Transfers are sometimes referred to as direct rollovers, and are not subject to the 20% IRS withholding tax, which we will discuss later on.

With a rollover, the retirement funds are distributed from the disbursing institution directly to the former account holder.  This means a check is sent directly to an individual, not another institution.

Unlike a transfer, a rollover is reported to the IRS.  This is to ensure that the individual receiving this money abides by the rollover rules, and deposits the money into another qualifying retirement account in a timely manner.

60-Day Rollover Rule

In general, you have 60 days to make the rollover contribution after receiving the distribution from your traditional IRA or an employer's qualifying plan such as a 401k or 403b.  The IRS might waive the 60-day requirement if you can demonstrate that a significant hardship or event occurred that was beyond your control.  If you want to try to get a waiver, a request for a ruling must be made and a fee may apply.

Rollover Extensions

You can qualify for an extension of the 60-day rule if the deposit becomes frozen at any time during the 60 days.  There are two specific rules that extend the rollover timeline.  Both of these rules have to do with frozen deposits:  money that is held by banks that have become insolvent or bankrupt.

If the distribution becomes a frozen deposit, then the time during which the money is frozen does not count towards the 60 day timeframe.  Also, the 60 days cannot expire less than 10 days after the deposit is no longer frozen.

Rollover Withholding

If an eligible rollover is paid directly to you, then the distribution may be subject to 20% withholding.  This rule applies even if you are merely rolling it over into a traditional IRA.  To avoid any tax penalties, you need to rollover 100% of your account money withdrawn into the receiving account.

Rollover Withholding Example

Let's take a closer look at this withholding rule.  Let's say that you have $10,000 in an account that you want to rollover to a new retirement account.  If the money is sent directly to you, then you'll receive $8,000 (20% will be withheld).  To avoid any tax penalties, you will have to send $10,000 to the receiving account.  That means you need to make sure you have access to funds to make up for the 20% withheld.  In this example, that amount is $2,000.

You can avoid the 20% withholding by having the distribution set up as a direct rollover, or transfer, as mentioned above.  This means the money goes directly from the withdrawal account to the receiving account.  Retirement plan administrators provide this service all the time, and they can help walk you through the process.

Future Contributions and Rollover IRAs

There are some benefits of keeping a rollover IRA separate from any other IRAs you've funded in the past, or would consider funding in the future.  That's because once you make personal contributions to a rollover that is not from a company-sponsored plan, you will very likely lose the ability to move that rollover to your new company's sponsored plan.

Rollover IRA Withdrawal Rules

The withdrawal rules for a rollover IRA are exactly the same as the rules for a traditional IRA.  The contributions and earnings are taxed when withdrawn after age 59 1/2.  Any withdrawals before the age 59 1/2 are taxable and subject to a 10% tax penalty.  Mandatory withdrawals from a rollover IRA begin the year after you reach age 70 1/2.

For more information on these types of distributions, including allowed exceptions to these rules, see our publication on IRA Withdrawals.

Roth IRA Rollovers

Finally, we'd like to mention that there is no such thing as a Roth IRA rollover.  That's because the IRS refers to the process of rolling-over a traditional IRA to a Roth IRA a conversion.  Unfortunately, the topic of converting a traditional IRA into a Roth IRA is far too complex to discuss in this publication.

There are worksheets involved to figure out if you qualify; there are tax and withholding implications too.  This subject is best discussed with a tax professional.  For the ambitious readers out there, you can take a look at this 100 page publication put out by the IRS - Publication 590, which thoroughly discusses the topic of IRA conversions.

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