To many in the job market, one might as well be speaking a foreign language when you talk about IRA rollovers and other retirement techniques, but it’s a pretty simple but you want to be careful to avoid excess taxation and fees.
A rollover is where you transfer your funds from a 401(k) or profit-sharing plan to a traditional IRA or Roth IRA. You may consider this when you change jobs, or when you retire to protect assets.
As Winnie Sun explains, there are three different paths you can take to achieve this goal:
- 60-Day Rollover – The distribution is payable to you. You, in turn, have 60 days to contribute it to the new IRA. Taxes will be withheld from a distribution from a retirement plan, so you’ll have to use other funds to rollover the full amount of the distribution.If you do not complete this within the 60-day time period, the money is considered income by the IRS and taxed at your normal rate (and if you are younger than 59-1/2, you will be hit with a 10% penalty for early withdrawal). There are special cases where a waiver or an extension of the 60-day period may be granted.These rollovers must be reported on your tax return as a non-taxable transaction. (Make sure the 1099-R form you receive is correct to avoid potential taxes.)There are other limitations, such as the one-year waiting rule. If you have rolled over part of an IRA into a second IRA, you must wait one year before rolling over any other part of the original IRA (whether it is going into the second IRA or a third IRA). However, this one-year limit does not apply to rollovers from qualified employer plans, 403(b) or 457 accounts, or rollovers from Traditional to Roth IRA’s.
- Direct Rollover – The distribution check is sent to you but made out to the institution handling your new IRA. You may be involved with the physical handling of a check, but the distribution is never made out directly to you. This transaction is reportable, but non-taxable, and there is no 60-day window with which to be concerned. If this is an option for you when rolling over an employer-based plan or similar qualifying program, choose this path to avoid a 20% withholding tax on the transfer (required if these types of plans are distributed directly to you in a 60-day rollover).
- Trustee to Trustee – Transfers go directly from institution to institution. If you are only transferring IRA’s from one institution to the other, this is the way to go. Transfers are not reportable, taxable, or subject to any 60-day window or the one-year waiting rule. This assumes that you do not need access to any of the money right away; if you do, this is not an option.
[You may also want to consider rolling over your Traditional IRA into a Roth IRA, or creating both a Traditional and Roth IRA. Address this with a financial advisor, as a Roth IRA contains money on which you have already paid taxes, whereas a traditional IRA is taxed only upon withdrawal of funds at the applicable rate.] Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.