If you have a retirement plan from a previous job or an individual retirement account, there are ways to move the funds without getting penalized by the Internal Revenue Service. These transfers, or “rollovers,” can be directed through a plan administrator or financial institution, but you can also make the switch too. If you do it yourself, be careful to avoid any of the following mistakes that can lead to tax penalties.
Missing the 60-day cutoff
If distributions from a retirement fund are paid directly to you, the Internal Revenue Service gives you 60 days to deposit the money from one plan or individual retirement account, or IRA, into a new retirement account. If administrator errors, emergencies or other qualified delays arise, you may be eligible to receive an extension from the IRS.
In the event that you miss the 60 days without an extension, any pretax money in your account now becomes part of your taxable income for that year. If you're under 59½ years old, you also might pay an early-withdrawal penalty of 10% on that money.
Not waiting a year to do another IRA rollover
In most cases, the IRS limits you to only one rollover involving the same IRA in a year. So if you have two traditional IRAs (or two Roth IRAs) and roll over money from one to another, you can't do another rollover using either IRA for a year, whether to or from either one. The consequences of doing a second IRA rollover too soon can include paying the early withdrawal penalty and adding the previously untaxed IRA funds onto your year's taxable income.
However, this one-year rule doesn't apply in the following cases:
- A rollover from an employer-sponsored plan, such as a 401(k), to another, which a plan administrator can make on your behalf.
- A rollover from such a plan to an IRA.
- A rollover from a traditional IRA to a Roth IRA, which is also called a conversion.
- A trustee, such as a financial institution, makes a transfer from one IRA to another on your behalf.
- A trustee transfers money from your IRA to a plan.
For a display of the acceptable rollovers from various retirement accounts, check out the IRS' chart.
Trying to roll over required minimum distributions
You can be compelled to start taking out required minimum distributions, or RMDs, from a traditional IRA, 401(k) or other fund once you turn 70½. Make sure to avoid rolling any of these funds over into another IRA as this wouldn't be an approved transfer. However, once you take out the RMD for a year, you may be able to roll over that money into another account without penalty. The sole exception to this is Roth IRAs, which don't have a RMD requirement until the owner's death.
Not transferring the same distribution to a new account during rollovers
The IRS' “same property” rule mandates that the retirement money you receive from a 401(k) administrator or IRA holder is the same money you roll over to a new account. If you repurpose any of it for another use, that amount is susceptible to tax penalties.
Some funds can also be withheld for taxes by a plan administrator or account manager before distributing the money to you. This withholding acts as a kind of insurance policy for the IRS, in case an IRA or 401(k) participant spends all of a distribution and doesn't pay taxes on the money. The amount withheld is 10% of distributions from IRAs and 20% from retirement plans, according to current IRS rules. So as you execute the rollover, it's up to you to make up that 10% or 20% from other sources to avoid tax penalties.
For example, if your “eligible rollover distribution” is $10,000 and an employer withholds $2,000 for taxes, it's up to you to make up that $2,000 when you roll over to a new account. If you don't, you'll pay taxes on that $2,000 and an early-withdrawal penalty, if applicable. You'd still report the $2,000 as taxes paid in either case and may be refunded if you end up owing less on that distribution.
As you make plans to roll over retirement funds to other accounts, make sure that you stay within the IRS guidelines. You don't want to end up with any extra costs from early withdrawals and penalties for money that you've built up for years for retirement.
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