IRA Rollover Rules to Know
By James I. Moore, CFP®
Are you wondering about IRA rollover rules? Perhaps you want to move your 401(k) or 403(b) from your employer’s plan into an IRA, or maybe you want to move an existing IRA into another IRA. Whether it’s account consolidation or better investment options, there could be a lot of reasons why an IRA rollover makes sense for you.
If you are considering a rollover, it is important to understand the rules so you can avoid some common pitfalls. There are some seemingly minor mistakes that can cause some big tax penalties, so it’s best to be careful during the rollover process. Here are a few IRA rollover rules to know.
Is My Retirement Account Eligible for an IRA Rollover?
The IRS has provided a helpful chart showing which types of accounts are eligible for rollovers. When most people think of a rollover, they probably are thinking of taking funds from an employer plan like a 401(k) or 403(b) and moving them into an IRA. But as you can see in the chart, the IRS allows you to move funds between a wide variety of retirement accounts.
It’s important to note that even if a rollover looks permissible according to this chart, a retirement plan may have additional restrictions that disallow a rollover for you. For example, many employer 401(k) plans allow rollovers only after you have “separated from service” (i.e., left employment).
Typically, most people consider rolling over their retirement account only when they change jobs or retire, but some plans do allow for rollovers during employment. If you are in a qualified plan and want to initiate a rollover, the first step is to contact your plan administrator to make sure the plan rules allow it. If not, any distribution from the account could be subject to an early withdrawal penalty and count as taxable income to you.
Also, make sure you don’t have a loan on the retirement account you want to roll over. Loans are not permitted from IRAs, so you won’t be able to roll over the loan to the IRA. Some retirement plans will allow you to roll over the net balance (account value minus loan balance), but any unpaid amount on the loan will be considered a default and will count as taxable income to you.
Additionally, if you are under the age of 59 ½, the unpaid loan amount would also be subject to a 10% penalty. If you do have a loan on your retirement account, it is best to contact the plan administrator and ask about the plan rules for a loan.
How Do I Process a Rollover?
Sometimes assets can be rolled over “in kind,” and sometimes they must be sold first before rolling over to the new account. Either way, if it’s done correctly, you will not owe any taxes by doing a rollover.
If the investments in the retirement account need to be sold first, you have two ways to process the rollover into the IRA. With a “direct” rollover, the funds from your retirement account are transferred directly to your IRA, without you ever personally taking receipt of the funds. With an “indirect” rollover, the funds from your retirement account are paid directly to you, and then you deposit those funds into your IRA within 60 days.
Of the two options, a direct rollover is preferable, if possible. An indirect rollover, also called a “60-day rollover,” can also work, but there are a lot of rules and potential penalties if it’s not done correctly.
For example, if the funds are not deposited into your IRA within 60 days, the rollover becomes a permanent distribution, and the entire amount of the rollover becomes taxable income to you.
Additionally, you are only allowed to make one of these 60-day rollovers every 12 months, which could potentially limit some of your options in the future. If the 60-day rollover is the only option for you, here are some helpful guidelines for 60-day rollovers.
The best way to avoid some of the pitfalls associated with a 60-day rollover is to do a “trustee to trustee” transfer. You can do this by asking the plan administrator or current custodian to transfer your retirement funds directly to the custodian of your rollover IRA. Doing it this way makes it clear that you have never taken personal control of the funds, and you do not need to worry about the 60-day rule or the 12-month rule.
Some plans do not give the option of sending payment directly to the new custodian and will issue a check directly to the account holder. In this case, it’s usually best to have the plan administrator make the check payable to the new IRA custodian. Even if the check is mailed to you, it will still count as a direct rollover as long as you forward the check to the new custodian and never deposit it in a personal account.
Required Minimum Distributions
If you are over age 70 ½ when you initiate your IRA rollover, be aware that the IRS requires the first dollars that come out of your account to go toward satisfying your required minimum distribution (RMD) for the year. This means that if you are over age 70 ½ and you roll over your RMD amount into your IRA, you could face penalties because the rollover would be considered an excess contribution.
You can prevent a penalty by making sure to remove the current year’s RMD before you initiate the rollover. Usually, the plan administrator will calculate and distribute the RMD automatically before the rest of the account is rolled over, but it is always good to check to make sure it is done correctly.
Many situations exist in which rolling over a retirement account into a new or existing IRA can make a lot of financial sense. A rollover IRA could allow for more investment options and flexibility compared with the limited options available in most retirement accounts inside company plans, but there are also some situations where it makes sense to leave your retirement account in place.
A fee-only financial advisor can help you determine if an IRA rollover fits in your overall financial plan and can help you with the implementation to make sure all the rules are followed.
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