There’s a good chance you’ll need to roll over an IRA or 401(k) plan at some point during your working life. In fact, there’s an outstanding chance you’ll need to do it several times. Retirement plan rollovers are actually pretty easy to perform.
It’s mostly a matter of knowing exactly what you need to do, so you will be able to make the rollover in the most tax-friendly manner possible.
So how do you rollover an IRA or 401(k) without paying penalty or early-withdrawal fees? We dive into the best and worst methods.
The IRA: The Foundational Retirement Plan
An IRA is something of the retirement plan of last resort. Most other retirement plans can be successfully rolled over into an IRA. And many retirement plans, including employer-sponsored plans, ultimately end up in IRAs at some point.
There are compelling reasons why you might want to roll your company-sponsored plan over into an IRA, rather than the plan of your next employer:
- IRAs are completely self-directed, giving you control over all of the investment activity
- You can choose the plan trustee and change it later on
- They typically have more investment choices than company-sponsored plans
- You generally have more flexibility in withdrawing funds from an IRA than you do with an employer plan
- You can invest in your IRA to make investment fees lower than they would be an employer plan
- In general, IRAs have fewer restrictions than other types of retirement plans
One of the few rollover restrictions for an IRA is the one year waiting period for IRA rollovers. Under IRS rules, if you make a tax-free rollover of the distribution from an IRA, you generally cannot make another rollover from the same IRA within a one year period. You also cannot make the rollover from the IRA to which the distribution was rolled over.
Rollovers between retirement plans are generally permitted for most plans. Some common examples include:
- IRA to IRA — Except for the one year rule above, you can roll over one IRA to another as you see fit.
- IRA to 401(k) — This one takes a lot of people by surprise. You can perform this rollover as long as the new employer 401(k) plan allows it. You are also restricted to rolling over only the tax-deductible portion of your IRA plan. Any amounts not tax-deductible cannot be rolled over into a 401(k) plan. Depending upon the terms of the new 401(k) plan, a rollover can be considerably more complicated. You have to check with the new plan trustee to determine specifically what those terms will be and what you’ll need to do.
- 401(k) to an IRA — This is probably the most common type of rollover. It’s so common, in fact, most plans are able to make it happen with relatively little effort on your part. The most common reason for a 401(k)-to-IRA rollover happens when you leave an employer where you have a 401(k) plan. You may do this several times in your career, and most people will roll the funds over into an IRA.
- 401(k) to another 401(k) — This is permissible as long as the plan with the new employer allows it. If it does, there may additional rules specific to the new plan.
- 401(k) or Traditional IRA to a Roth IRA — Due to the potential tax consequences of converting tax-sheltered retirement savings to a Roth IRA, this is a separate discussion we won’t spend time on here. You can get information on rollovers to a Roth IRA on this Investor Junkie article.
Whatever type of retirement plan rollover you’re attempting to do, be sure you follow proper procedures which will allow you to do it without suffering any tax consequences and fees — we’ll get to those in a minute.
General Rollover Terms
Before getting into the mechanics of rolling over funds from one plan to another, there are a few terms you need to be familiar with:
Direct rollover. This is where one plan trustee issues the distribution check directly to a new plan trustee. This is the simplest form of transfer, and avoids the possibility of triggering income tax liability.
Indirect rollover. This is a distribution in which the funds are distributed to you, rather than to the new trustee. Indirect rollovers are subject to withholding equal to 10% of the distribution amount from an IRA and 20% from other retirement plans.
60-day rollover requirement. Any retirement funds received by you not rolled over into a new plan within 60 days are considered to be a cash withdrawal and subject to income tax.
IRS 10% additional tax on early withdrawals. If distributions are considered to be cash withdrawals, they will be subject to a 10% additional tax on early withdrawal if they are taken before you turn 59 ½ and there are no exceptions (such as hardship withdrawals).
The Mechanics of a Successful Rollover
No matter what type of retirement plan rollover you’re trying to do, the basic methodology is about the same. Whatever type of rollover you’re trying to perform, be prepared to do the following:
- Step 1: Set up your IRA account before beginning the transfer — If you receive the distribution from your old plan, then go out looking for a home for it, you will risk mistakes which could possibly lead to tax consequences.
- Step 2: Contact the current plan administrator — Administrators typically have set procedures on handling rollovers. Let them know you want to do a direct rollover of your old plan into the new one. This will enable you to avoid withholding taxes on the distribution.
- Step 3: Make sure the check is made out to the new plan trustee — If the transfer check is made payable to you personally (which is an indirect transfer) the trustee on the old plan will have to withhold income taxes. This will reduce the amount of the rollover, and subject you to actual taxes — plus the 10% additional tax on early withdrawals — on the amount of the withholding.
- Step 4: Deposit the check within 60 days — Better yet, deposit it immediately so you don’t forget about it. If the funds are not deposited within the 60 day window, it will be considered a regular distribution, subject not only to income taxes, but also the 10% penalty if you are under age 59 ½.
- Step 5: Report the rollover on your income taxes — This is actually a simple affair as long as there is no tax liability on the distribution (and there won’t be if you handle the transfer correctly). Your old plan trustee will issue you an IRS Form 1099-R, reporting the amount of the rollover. It will also indicate it is a non-taxable distribution.
If you’re ever in doubt as to how to properly structure your retirement rollover, consult with both the old plan trustee and the new one. The rules for a rollover are very specific, and both trustees will have an established protocol that should make the rollover a stress-free affair.
For more information, check out the IRS website for more specific requirements on retirement plan rollovers.