Are you changing jobs, retiring, or moving your retirement plan assets? Is so, consider having these assets rolled into an eligible retirement plan instead of having them paid to you. This will not only allow you to continue enjoying tax-deferred earnings on these assets, but will also help prevent the tax-withholding requirements that are applied to some retirement plan assets that are not rolled directly to an eligible retirement plan.

Tutorial: Retirement Planning Basics

Expanded Rollover Options
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made significant changes, such as increasing contribution limits to retirement plans. EGTRRA also liberalized the rules regarding the permissible movement (portability) of assets between eligible retirement plans. The changes to these rules now allow you to roll over after-tax assets from your 401(k) plan; furthermore, if you are the spouse beneficiary of a deceased qualified-plan participant, you are now able to roll the inherited assets into your own retirement plan.

Rollover-Eligible Assets

Should you decide to roll over your retirement assets to another eligible retirement plan, you need to be aware of the types of distributions that may be rolled over without excises, taxes or penalties. The following are some types of distributions from qualified plans that you should not roll to your IRA or other eligible retirement plan account:

  • Amounts representing required minimum distributions
  • Amounts withdrawn due to financial hardships
  • Excess contributions that your employer returns to you
  • Loans that are treated as distributions because they do not meet regulatory requirements
  • Distributions that are part of a series of substantially equal periodic pension or annuity payments made at least once per year for at least 10 years and amounts calculated using your life expectancy or the joint life expectancy of you and your beneficiary
  • Distributions for the cost of life insurance coverage
  • Distributions made to you after the death of a qualified plan participant of whom you are a non-spouse beneficiary

To be sure, check with your employer or plan administrator regarding the rollover eligibility of your retirement plan assets. You should bear in mind that in order to distribute assets from a qualified plan, a 403(b) account or governmental 457 plan, you must meet certain requirements. Your employer should be able to explain these requirements.

Tax-Withholding Requirements
For rollover-eligible assets, you have three options when withdrawing these amounts from a qualified plan:

  • Keeping the assets (no rollover)
  • Having the assets paid directly to you and rolling over the amount within 60 days after you receive the distribution (indirect rollover)
  • Having the assets paid directly to the trustee or custodian of your eligible retirement plan (direct rollover )

Withholding rules apply for the first two options but not for the third option. When rollover-eligible assets are paid directly to you, your employer or the payer is required to withhold a minimum of 20% for federal taxes. Financial institutions that perform state tax withholding may also be required to withhold additional amounts for state taxes. In addition, if you are under age 59.5 when the distribution occurs, you may, unless you meet an exception, be subject to an additional 10% early-distribution penalty. This 10% applies to any amount you do not roll over within 60 days after you receive the assets.

Should you later decide to roll over assets you received as an indirect rollover, you may either roll over the amount you received or roll over the total amount distributed. To roll over the total amount distributed, you will need to make up the difference out of pocket.

Example: Rolling Over 401(k) Assets
Suppose that you request a distribution of $10,000 from your 401(k) plan account. Instead of having the assets rolled directly to your IRA held with ABC Financial Institution, you request to have the amount paid directly to you. In keeping with regulatory requirements, your employer withholds 20% ($2,000) for federal taxes and gives you a check for $8,000, which you deposit to your savings account. A month later, you decide to roll over the total amount distributed ($10,000). Given that your employer withheld $2,000 to be submitted to the IRS as payment of federal taxes, you must take the $2,000 from your other sources to add to the $8,000.

Alternatively, you may roll over only the $8,000. In this case, the remaining $2,000 that was not rolled to your retirement account will be treated as ordinary income and may be subject to an early-distribution penalty.

Summarizing Retirement Plan Rollover Rules
The following chart summarizes the rules regarding the types of plans between which you can move your retirement assets:

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Additional Rules

  • Amounts representing required minimum distributions cannot be rolled over to an eligible retirement plan.
  • Assets in a Roth IRA may be moved to a Traditional IRA or a SIMPLE IRA only if the assets were credited to the Roth IRA as a conversion and are subsequently being recharacterized to the account of origin.
  • Rollover of after tax-assets from a qualified plan to another qualified plan must be done as a direct trustee-to-trustee transfer.
  • Although the law allows the rollover of eligible assets to qualified plans, your employer is not required to make these allowances. Before electing to have your retirement assets rolled to the qualified plan in which you participate, check with your employer or the plan administrator regarding what they permit for their specific plan.
  • Should you decide to roll over after-tax assets to your IRA, you will be required to account for these assets separately. This will help you avoid paying taxes and penalties on distributions that should be tax and penalty free. You must also file certain forms with your tax return to account for these assets. Consult with your tax advisor regarding the appropriate forms that must be filed.

The Bottom Line
Rolling over retirement plan assets can be a complicated matter, so approach any move carefully to avoid unwanted penalties. If you were born before 1936, special tax benefits may be available to you if you choose not to roll over your distribution from a qualified plan. Regardless of when you were born, it may be in your best interest to consult with your financial professional to ensure that you make the right choices.

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