When you rollover a qualified retirement account (like a pension plan lump sum, 401k, or 403b) to an IRA, or transfer funds or investments from one IRA to another, if done correctly, it is not considered an IRA withdrawal. Since there is no distribution of funds to you, the transfer is tax-free.
There are subtle differences between what is considered an IRA rollover, and what is considered an IRA transfer. The important thing to know; with either one the funds must be deposited in the new account no longer than 60 days from the time they were withdrawn from the old one.
Below are eight frequently asked questions about IRA rollovers.
1. Can I Use An IRA Rollover To Move Funds Out Of My Employer Sponsored Plan While I Still Work There?
Most employer sponsored retirement plans do not allow you to roll funds out of the plan while you are still employed. To find out if they do, you can call your plan sponsor, and ask if they allow what is called an "in-service distribution".
An in-service distribution is not the same thing as a loan or hardship withdrawal. Instead, for those few plans that allow it, an in-service distribution is a transaction where you can rollover funds for your plan into a self-directed IRA account while you are still employed.
No Longer Employed
Once you are no longer employed, it may make sense to roll funds from your plan into an IRA account. At that time, to avoid tax withholding, you'll want to choose what is called a direct IRA rollover.
2. Will Taxes Be Withheld When I Move Funds From My Employer Plan To An IRA Rollover?
When rolling funds from an employer sponsored plan to your IRA, you can avoid mandatory tax withholding (explained below) by requesting a direct rollover. In this case, although the check may be mailed to you, it will be made payable directly to your new trustee or custodian.
Mandatory Tax Withholding Required If IRA Rollover Distribution Paid To You
If an eligible rollover distribution is paid directly to you, the payer must withhold 20% of it, which they send directly to the IRS for taxes. This applies even if you plan to roll over the distribution to a traditional IRA.
You can avoid tax withholding by choosing a direct rollover option, where the distribution check is payable directly to your new trustee or custodian.
3. Will I Be Taxed If I Transfer Funds From One IRA To Another IRA?
An IRA transfer occurs when your move IRA funds from one trustee (or custodian) directly to another trustee, either at your request or at the trustee's request. As long as there is no distribution payable to you, the transfer is tax free.
4. Can I Use My IRA Funds Tax-Free If I Deposit Them Back Into My IRA?
If you withdraw funds from an IRA, and then subsequently redeposit them to your IRA within 60 days, the transaction would not be taxed.
Use caution - since your custodian does not know if you will be redepositing the funds, they may be required to withhold 20% in taxes from your initial distribution. You would have to be able to repay this 20% out of pocket. You would recover it when you filed your tax return.
You could use this 60 day provision to "borrow" funds from your IRA for a short period of time. However, if any portion of the distribution is not repaid within the 60 days, and you are under age 59 1/2, it would be considered an IRA early withdrawal, subject to taxes and penalties, unless you could qualify for an exception.
Once A Year IRA Rollover Provision
You can withdraw, tax free, all or part of the assets from one traditional IRA if you reinvest them within 60 days in the same or another traditional IRA. You can only use this provision once per year, per each receiving and distributing IRA account.
You cannot roll funds from IRA-1 to IRA-2 over 60 days, then from IRA-2 to IRA-3 over another 60 days, and so on. However if you had four IRA accounts to begin with, then within the same year you could use the 60 day rollover provision between IRA 1 and 2, and between IRA 3 and 4.
Eligible rollover provisions from employer sponsored retirement plans are not subject to the once-a-year provision.
5. Can I Use An IRA Rollover To Move Just Part Of My Account?
IRA rollovers are not an all-or-nothing proposition. You can use an IRA rollover to move just a portion of your funds from one IRA to another, or to rollover just part of a qualified plan to an IRA.
6. I Inherited An IRA. Can I Roll This Into My Own IRA?
If you inherit a traditional IRA from your spouse, you can roll the funds into your own IRA, or you can choose to title it as an inherited IRA. There are pros and cons to doing it either way.
IRA Not Inherited From A Spouse
If you inherit a traditional IRA from someone other than your spouse, you cannot roll it over or allow it to receive a rollover contribution. You must withdraw the IRA assets within a specified period of time.
7. Can I Rollover My Required Minimum Distributions?
Amounts that must be distributed during a particular year under the required minimum distribution rules are not eligible for IRA rollover treatment.
8. Do I Have To Report IRA Rollover Transactions On My Tax Return?
IRA rollovers are reported on your tax return, but as a non-taxable transaction. Even if you correctly execute an IRA rollover, it is possible that your plan trustee or custodian will report it wrong on the 1099-R they issue to you and to the IRS. I have seen this occur many times in my career.
If your custodian reported the transaction incorrectly, and you hand off the documentation to your tax-preparer without explaining the transaction to them, it could get reported on your return incorrectly.
To make sure you don't pay tax on an IRA rollover or transfer, carefully explain any IRA rollover or transfer transactions to your tax preparer, or double check all documentation if you prepare your own return.
9. Can I Rollover After-Tax Funds to a Roth IRA?
The tax laws are not crystal clear on this. Many people do rollover after-tax 401k money to a Roth, but you may be taking a risk that the transaction could be disallowed. Here is a summary of the current thinking on rolling after-tax 401k money to a Roth.