Reverse Rollover

A reverse rollover involves moving money from an individual retirement account (IRA) into a 401(k) or similar employer-sponsored retirement savings plan. Reverse rollovers have several potential tax advantages if your employer allows them. Here is how one works and when it might make sense for you.    

What Is a Reverse Rollover?

In a typical IRA rollover, you move money from a 401(k) or other employer-sponsored retirement savings plan into an IRA, when you either change jobs or retire. In a reverse rollover, you move your money in the opposite direction: from an IRA into a 401(k) or similar plan. However, you are only allowed to move pretax money into the 401(k).

One reason why you might want to do a reverse rollover is to disentangle your deductible and nondeductible traditional IRA contributions so that you then can do a typical Roth IRA conversion tax free. Another is to avoid (or at least reduce) the required minimum distributions (RMDs) that you normally would have once you reach age 73 for individuals born between 1951 and 1959 and age 75 for those born in 1960 or later.

How a Reverse Rollover Works

Not all employers allow reverse rollovers into their 401(k)s or similar defined-contribution plans, so before you do anything else, you might want to check with your plan administrator. Ask if your plan accepts reverse rollovers and, if so, how you should move the money. You will probably want to do it as a direct transfer, also known as a trustee-to-trustee transfer, which will avoid mandatory 20% tax withholding.

If you’re in a position to proceed, the first step is adding up the total value of your traditional IRAs and determining what portion of your contributions were either pretax (for which you took a tax deduction at the time) or after-tax (for which you didn’t receive a deduction). For tax purposes, the Internal Revenue Service (IRS) considers all of your traditional IRAs as if they were one big IRA.

You can find your nondeductible, after-tax contributions by consulting the IRS Form 8606 that you would have filed with your tax return for each year that you made them. Once you do, subtract the nondeductible amount from the total amount in your IRAs. This is the amount that you can roll over in reverse.

In addition, after your reverse rollover is completed, you may be able to avoid RMDs entirely—or at least postpone a portion of them. Roth IRAs are never subject to RMDs during your lifetime. Like a traditional IRA, the money in your 401(k) is normally subject to RMDs once you reach age 73 (for people born between 1951 and 1959) and age 75 (for those born in 1960 or later). However, some employer plans offer what’s known as a “still-working exception,” which allows you to defer RMDs until the calendar year when you retire from that employer.

Example of a Reverse Rollover

Suppose you have a total of $100,000 in traditional IRAs, of which $30,000 was pretax contributions, $20,000 was after-tax contributions, and the remaining $50,000 is earnings (which have yet to be taxed). Your after-tax contributions represent 20% of your total IRA.

Under normal circumstances, if you wanted to convert your traditional IRA into a Roth, you would need to prorate it. (Unfortunately, you can’t simply convert your nondeductible contributions.) In this example, 80% of the amount that you convert (the pretax portion) would be taxable, while 20% of it would be tax free.

Instead, if you were to do a reverse rollover of $80,000 (representing the pretax 80% part of your IRA) into your 401(k), you would now have just $20,000 in your IRA, all of which would be tax free when you make the conversion. You also won’t incur any tax on the reverse rollover if you do it properly.

Note that you can only use pretax funds in a reverse rollover, so you still would be limited to rolling over $80,000 in this example.

The Bottom Line

A reverse rollover—from a traditional IRA to a 401(k)—can have two potential benefits: delaying when you must start taking RMDs, and making it possible to convert traditional IRA contributions that already have been taxed into a Roth IRA tax free. As with many tax matters, a slipup could be costly, so consulting a knowledgeable certified public accountant (CPA) or financial planner may be worth the cost.