By Sarah Brenner, JD
The road to retirement is long. Along the way you may need or want to move your retirement funds. Maybe you are leaving a job or maybe you are just looking for a new investment strategy. When the time comes to make a move, you will want to be sure that everything is done correctly. Rolling over retirement funds can be tricky and the consequences of a mistake can be serious. Here are 6 things about rollovers that every IRA owner needs to know.
1. How rollovers work
A 60-day rollover starts with a distribution from a retirement plan payable to you. The distribution can be from a company plan or an IRA. You will have receipt of the funds.
A direct rollover is paid from a company plan to another company plan or IRA. Though this transaction is called a “rollover,” it is very different from a 60-day rollover because you do not have receipt of the funds. A direct rollover avoids the mandatory 20% withholding that applies to rollover-eligible distributions from company plans.
When funds are moved directly between IRAs that transaction is not a rollover. It is instead a transfer. In a transfer, the funds are sent directly from one IRA custodian to another. Transfers are not subject to the many rules that restrict rollovers.
2. The 60-day rule
You do not have unlimited time to complete a rollover. Instead, there is a 60-day window to get it done. The 60-day clock starts ticking when the distribution is received. During the 60-day period the funds may be used for any purpose.
While there are some very limited exceptions, in general, if the deadline is missed then no rollover is possible. The distribution would be taxable and subject to penalty, if applicable. To avoid this outcome, complete rollovers sooner rather than later. Waiting until the last minute can be a recipe for disaster.
3. The Once-per-Year Rollover Rule
IRA-to-IRA or Roth-to-Roth rollovers are subject to a once-per-year rule. For purposes of this rule, traditional and Roth IRAs are combined. This means that a distribution and subsequent rollover between your Roth IRAs will prevent another rollover within a one-year period between either your traditional IRAs or other Roth IRAs.
This rule limits you to only one rollover of IRA funds every 12 months.
Rollovers from a company plan to an IRA or from an IRA to a company are not subject to the once-per year rollover rule. Roth conversion are not subject to the rule either.
4. No Rollover of RMDs
If you are 70 ½ or over during the year, rollovers will come with an extra rule. Your RMD may not be rolled over. The way the rules work, the first money out of the retirement account is the RMD for the year. You do not have the option of rolling over the full amount and simply taking the RMD later. Instead, the client will need to take the RMD at the time of the distribution. Any amount above the RMD amount can then be rolled over.
This rule does not apply to transfers between IRAs. If a client transfers his IRA, he may transfer the entire account and take the RMD later from the new IRA.
5. Other Rollover Pitfalls
There are rollover pitfalls to look out for. One all-too common mistake involves non-spouse beneficiaries attempting to rollover retirement funds. This is not allowed. If a non-spouse beneficiary receives a distribution from an IRA or company plan, they may not roll over those funds.
Another frequent error involves distributions of property from an IRA. The rules require that if property is distributed from an IRA, the same property must be rolled over. The client may not sell the property and substitute cash in the rollover. This rule does not apply to distributions from employer plans.
6. Avoid Rollovers
The rollover rules are complicated. There are many ways to go wrong. The best strategy is to use transfers to move IRA funds and direct rollovers to move funds from plans to IRAs.
A transfer avoids both the 60-day rule and the once-per-year rollover rule. There is no concern about missed deadlines and no restriction on the frequency of transfers. Also, it allows more flexibility in the timing of RMDs. IRA transfers have the additional benefit of not needing to be reported to the IRS by either the client or the custodian.
With a direct rollover, you avoid concerns about 60-day rule. Because the 20% withholding rule does not apply to direct rollovers, the entire amount distributed from the plan can be deposited as a rollover without complication. This avoids the dilemma that occurs when a plan distribution is paid to you. You may roll over the entire distribution in a 60-day rollover but will have to make up the withholding from other sources such as a bank account or personal loan. This is not always ideal.