Note: this not an exhaustive discussion of rollovers by any means – please consider professional advice before doing a rollover – the consequences of a mistake can be very expensive!
What is an IRA Rollover?
The term IRA rollover is typically used when describing an exchange of assets from a qualified retirement (e.g. 401k, 403b) plan account to an IRA. The term rollover is often used interchangeably with the word transfer, We use the term “Transfer” when assets are directly sent from one custodian to another between TWO IRA’s (no qualified plan involved). Without touching the hands of the account owner.
2 Types of Rollovers
There are two kinds of rollovers – a direct rollover/transfer, or a “60 day rollover.” A direct rollover is when the custodian of a qualified plan, or workplace plan, cuts a check directly to the IRA custodian or electronically transfers the assets directly to the new IRA custodian for the benefit of the account owner. For example, a direct rollover check might be worded like this:
Payable to TD Ameritrade for the benefit of Abraham Lincoln; reference account # 123456789 in memo.
A 60 day rollover is when the qualified plan custodian or IRA custodian cuts the check directly to the individual, who deposits the money in their account and has 60 days to turn around and fund the IRA. One little caveat here – in 1993, in order to catch some people off-guard, ahem, keep people from playing with the money for 60 days and losing it, Congress instituted a 20% withholding provision on any 401k to IRA rollovers remitted to the participant/employee. This withholding will automatically be held by the company sending the money – no choice to the employee on this. And to make it worse, the employee must fund that 20% within the 60 days or face an early withdrawal penalty if IRA funds are used and only 80% of rollover amount goes into new account.
[Confusing isn’t it? Personally, I get angry when tricky tax rules make people lose money!]
Note that under recent IRS guidance, only one 60 day rollover from your IRA is permitted per year. However, unlimited transfers are allowed (that move directly between custodians, remember?).
Who Would Consider a Rollover?
People considering rollovers are typically those retiring or changing jobs and looking for more flexibility. Also, some of the IRA-only tax advantages can be captured if one transfers their 401(k) to an IRA. For example, let’s say you are 28 years old and you have $24,000 in your 401(k) with your former company. And you’d like to buy a house. You have $8,000 in the bank. But you don’t want to blow your emergency fund on a down payment. You can roll that 401k balance to a new IRA. And then take advantage of the tax rule that allows IRA owners to withdraw $10,000 from an IRA penalty free to buy their first home. You will still owe taxes but the idea is that one can not do this with 401k money. It must be transferred to the IRA.
How to Get Started
How does one proceed with a rollover? If you are doing this yourself, call the company that holds your account and get their rules on rollovers and ask them what they require to do it. If you feel intimidated or prefer not to be bothered with it, get a pro to take care of it for you.
Bottom line – this is an area that can appear simple but offers many possible traps. I highly recommend you obtain professional advice on doing a rollover or transfer.
Further Reading on IRAs & Rollovers
If you are interested in more reading on retirement plans, try these other articles:
Did you make a 60 day rollover mistake? The IRS may offer you relief:
60 Day Rollover Waivers (via IRS.gov)
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