A rollover is a tax-free transfer of cash or other property from one retirement plan to another. A quite common one is rolling over a 401(k) into an IRA. The rule permits rollovers between most tax deferred arrangements (eligible retirement accounts). Eligible retirement accounts include the following: qualified plans, 403(b) plans, Section 457 plans maintained by governmental entities only, and IRAs, SEPs (Simplified Employee Pension), SARSEPs, and SIMPLE (Savings Incentive Match Plan for Employees) IRAs.
Nondeductible after-tax IRA contributions cannot be rolled over into qualified plans, 403(b) plans, or Section 457 governmental plans. Even though rollovers between most tax-deferred arrangements are permitted, the law does not require an eligible retirement account to accept rollovers from another eligible retirement account.
The Pros and Cons of Rollovers
- Tax deferral generally results in more money in the client’s account. The money that normally would have been paid out to taxes, now remains in the account and earns interest.
- An IRA owner has complete control over the investment of his or her IRA assets.
- Numerous investment options are available to an IRA owner.
- IRAs are not subject to the withdrawal restrictions imposed by qualified plans.
- The client may need the funds for current living expenses. Few retired people can maintain their preretirement living standard on Social Security and personal savings. Most need to supplement those sources with distributions from their qualified retirement plans. Thus, deferral may not be a feasible solution. (The client could, however, roll over the lump sum and take small periodic distributions from the IRA as needed. The bulk of the funds, in this instance, would continue to benefit from tax-deferral.)
- Individuals may face a premature distribution penalty upon a distribution from the IRA between ages 55 and 59½.
- Unlike some retirement plans, loans from an IRA are prohibited.
- In certain states, IRA assets are subject to the claims of non-bankruptcy creditors. As a practical matter, debtors would file for bankruptcy to protect their IRA assets from creditors. Ask your attorney for an explanation about the rights of non-bankruptcy creditors in your state to IRA assets.
Types of Rollovers
Depending on the situation: some of the available Rollover options are descried below.
The Conduit IRA acts as a way station between qualified plans. This IRA applies only to the person who expects to join a new employer and a new qualified retirement plan, then have that IRA be rolled into another qualified plan.
A direct rollover is an eligible rollover distribution paid directly to an eligible retirement plan for the benefit of the IRA owner, usually in the form of a direct transfer from an eligible retirement plan to an IRA or another eligible retirement plan. This means you do NOT take possession of the funds.
An indirect rollover is when the client takes a distribution from a qualified plan (effectively taking possession of the funds) and rolls it over to an IRA or the qualified plan of a new employer within 60-days. A 20% tax rate withholding is typically imposed on a qualified plan or TSA distribution if the plan issues a distribution check to the recipient.
A spousal beneficiary rollover is the transfer of retirement fund assets to the surviving spouse of the deceased. The surviving spouse can have the retirement account remain intact and be renamed as the new owner. The other option is to transfer the funds to the spouse's account.
A non-spouse beneficiary rollover is when an account holder dies and does not leave their benefits to their spouse.
- If the account holder's death occurred prior to the required beginning date (or if the account is a Roth IRA), the non-spouse beneficiary's options are:
- Take distributions based on their own life expectancy, beginning the end of the year following the year of death, or
- Follow the 5-year rule.
- If the account holder's death occurred after the required beginning date, the non-spouse beneficiary may:
- take distributions based on the longer of their own life expectancy or the account owner's remaining life expectancy.
An In-Plan Rollover Roth allows a plan participant, spouse beneficiary, or a QDRO (Qualified Domestic Relations Order) recipient who is a spouse or a former spouse in a 401(k) plan, 403(b) plan, or governmental 457(b) plan to roll over non-Roth assets to a designated Roth account under the plan.