DEFINITION of Eligible Rollover Distribution

An eligible rollover distribution is a distribution from one qualified plan that is able to be rolled over to another eligible plan. Types of qualified plans include IRA and 403(b) plans. While an IRA is for a wide range of individuals and can be employer-sponsored, a 403(b) plan is specific to employees of public schools, tax-exempt organizations, and certain ministers.

BREAKING DOWN Eligible Rollover Distribution

Often, an eligible rollover distribution occurs when an individual moves from one employer to another. The rollover rules allow the individual to bring their prior assets to their new employer's retirement plan.

Qualified plans that allow for an eligible rollover distribution include both defined-benefit (DB) and defined-contribution (DC) plans. While defined-benefit plans give employees a guaranteed payout, defined-contribution plan distributions depend on how well an employee saves and invests on their own, as well as what the employer may contribute. A 401(k) is a popular example of a defined-contribution plan.

Other types of qualified plans include:

  • Profit-sharing plans
  • Money purchase plans
  • Target benefit plans
  • Employee stock ownership (ESOP) plans
  • Keogh (HR-10)
  • Simplified Employee Pension (SEP)
  • Savings Incentive Match Plan for Employees (SIMPLE)

You can read a comprehensive guide to common qualified plan requirements on the Internal Revenue Service (IRS) website. This guide also breaks down the plans by who is eligible, types of employers that sponsor the plans, and any risks or concerns that investors might have before entering into a plan agreement.

Eligible Rollover Distribution and Taxation

When rolling over funds from one account to another, it’s important to understand the corresponding rules and regulations so as not to incur any unexpected taxes or penalties. For example, in an IRA rollover, either via a direct transfer or by check, in many cases, a one-rollover-per-year grace period exists (although this does not always apply to rollovers between traditional IRAs and Roth IRAs). Those who violate this grace period could be liable to report any additional IRA-to-IRA transfers as gross income in the tax year when the rollover occurs.

No taxes are withheld for direct transfers; however, if the account holder receives a check that they personally deposit into their IRA, the IRS insists upon a withholding penalty. The IRS also stipulates that custodians or trustees must withhold 10% on checks from IRA distributions and 20% on distributions from other retirement accounts, regardless of whether or not the funds are earmarked for a rollover. At tax time, this amount appears as tax paid by the tax filer.