Direct Rollover

What Is a Direct Rollover?

A direct rollover is a qualified distribution of eligible assets from a qualified plan, 403(b) plan, or a governmental 457 plan into a traditional IRA, qualified plan, 403(b) plan, or a governmental 457 plan.

A direct rollover can also be a distribution from an IRA to a qualified plan, 403(b) plan or a governmental 457 plan. A direct rollover effectively allows a retirement saver to transfer funds from one retirement account to another without penalty and without creating a taxable event.

Key Takeaways

  • A direct rollover allows a retirement saver to transfer funds from one qualified account (such as a 401(k) plan) directly into another (such as an IRA).
  • The original fund custodian will draft a check or wire transfer made out to the new account custodian, and not to the account holder.
  • The purpose of a rollover is to maintain the tax-deferred status of those assets without creating a taxable event or incurring penalties.
  • To avoid penalties and taxes, the rollover must be effected within 60 days of withdrawing funds from the original account.

How Direct Rollovers Work

A rollover occurs when one withdraws cash or other assets from one eligible retirement plan and contributes all or a portion of this to another eligible plan. The account owner may be subject to a penalty if the transaction is not completed within 60 days. The rollover transaction isn't taxable, unless the rollover is to a Roth IRA, but the IRS requires that account owners report this on their federal tax return.

To engineer a direct rollover, an account holder needs to ask his plan administrator to draft a check and send it directly to the new 401(k) or IRA. In IRA-to-IRA transfers, the trustee from one plan sends the rollover amount to the trustee from the other plan. If an account holder receives a check from his existing IRA or retirement account, they can cash it and deposit the funds into the new IRA. However, they must complete the process within 60 days to avoid income taxes on the withdrawal. If they miss the 60-day deadline, the IRS treats the amount like an early distribution.

How They're Made Payable

Direct rollover assets are made payable to the qualified plan or IRA custodian or trustee and not to the individual. The distribution may be issued as a check made payable to the new account. For example, if an individual decides to switch employers and move her retirement assets built up over time in the first employer’s retirement plan, she must coordinate with the plan administrator, often an asset management firm like Fidelity or Vanguard, to close the account and write a check for the account balance to the new IRA custodian.

Some firms charge fees for this service although they are usually not substantial. On the other end, firms often charge small fees to open new accounts. If an employee is beginning a new job, often this new employer will assume the cost of setting up the new retirement account. Sometimes, the employee will have to wait several years or a vesting period before she may be eligible to open a new retirement account and have her employer begin making contributions.

Direct Rollover and Qualified Retirement Plans

As noted above, direct rollovers apply to qualified retirement plans. These are plans that meet certain criteria, such as non-discrimination among employees, to be eligible for certain tax benefits. These include an employer taking a tax deduction for contributions they make to the plan, employees taking a tax deduction on their own contributions, and earnings on all contributions being tax-deferred until withdrawn.

Defined Benefit vs. Defined Contribution

The two major types of qualified plans are defined benefit plans and defined contribution plans. A defined benefit plan is a more traditional pension plan in which benefits are based on a specific formula, often including the number of years of employee service times a salary factor. Defined contribution plans allocate money to plan participants, based on a percentage of each employee's earnings. The longer the employee participates in the plan, the higher the account balance grows, also based on investment earnings.

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