Banking 101: Understanding IRA Rollover Rules

If you change employers or you’re ready to retire, you might wonder what you should do with your old 401(k). One option is to roll the 401(k) over into an individual retirement account (IRA).

There are several good reasons to open a rollover IRA account. IRAs typically have more investment options than do 401(k) plans. And if you tend to hop jobs, you could wind up with a dozen or more accounts by the time you retire.

A rollover IRA can help you to consolidate past and future 401(k) balances into one account, but rollovers can have tax consequences if you don’t follow the rules. Here’s what you should know.

What is an IRA rollover?

Typically, distributions from a 401(k), IRA or other retirement savings account are taxable. If you’re under retirement age, you also might have to pay a 10% early-withdrawal penalty. For that reason, when you change jobs, you shouldn’t simply withdraw the funds.

An IRA rollover allows you to move the savings into a new retirement account while preserving the tax-deferred status of your retirement savings. You don’t have to move 100% of the funds in your account when you perform a rollover. You’re allowed to roll over a portion of your account balance as long as you follow other applicable rules.

How is an IRA rollover different from an IRA transfer?

Some people use the terms IRA rollover and IRA transfer interchangeably, and they’re similar. However, the main difference between a rollover and a transfer is that a transfer involves moving money between two accounts of the same type; a rollover involves moving money between two different types of accounts.

For example, when you leave one job for another, you might transfer the balance of your old 401(k) to your new employer’s 401(k) plan. However, if you move the money from a 401(k) into an IRA, that’s a rollover.

How do I roll over my retirement account?

There are three ways to roll over retirement savings.

• Direct rollover: Your retirement plan administrator can deposit the distribution from your retirement plan directly into another retirement plan or IRA. Alternatively, your employer might send you a check for the full amount of your account balance made payable to your new account, which you can deposit. Taxes won’t be withheld from the amount that’s transferred.
• Trustee-to-trustee: In this situation, which involves transfers from one IRA to another IRA, you can ask the financial institution that holds your IRA to make the distribution directly into another IRA or retirement plan. No taxes will be withheld.
• 60-day rollover: Sometimes, financial institutions issue distributions from an IRA or retirement plan directly to you. In this case, you have 60 days to deposit all or part of the distribution into another IRA or retirement plan. If the distribution comes from an IRA, you can elect to not have taxes withheld. However, if the distribution comes from a 401(k), the payee is required to withhold 20%.

What are the rules for rolling over a retirement account distribution?

Per IRS rules, you have 60 days from the date that you receive a retirement account distribution to roll it over into another account tax-free. If you miss the deadline because of circumstances beyond your control, the IRS might waive the 60-day rollover requirement. If you don’t qualify for a waiver, however, the distribution must be included in your taxable income that year, and you might have to pay an additional 10% early-withdrawal penalty.

You can take only one tax-free rollover per year, even if you have several accounts. However, per IRS guidelines, the one-rollover-per-year limit doesn’t apply to:

• Rollovers from traditional IRAs to Roth IRAs (also known as Roth conversions)
• Trustee-to-trustee transfers between IRAs
• Rollovers from IRAs to retirement plans
• Rollovers from retirement plans to IRAs
• Rollovers from retirement plans to retirement plans

Additional rules apply to different types of retirement account rollovers:

IRA CD rollover rules

For investors who own IRA CDs from various banks and credit unions to maximize interest rates, it’s more difficult to transfer savings to institutions that offer better deals. Multiple transfers still are allowed during a 12-month period, but they must be transferred directly from one custodian to another.

Roth IRA rollover rules

Roth IRAs can be rolled over only to another Roth IRA.

Traditional IRA rollover rules

Traditional IRAs can be rolled over into almost any other retirement account, including a 401(K), as long as the rules of the new account allow it to accept the rollover. If you want to roll a traditional IRA into a Roth IRA, that type of transaction is called a Roth conversion, and any contributions made with pretax money will be taxable income in the year you make the conversion.

SIMPLE IRA rollover rules

SIMPLE (Savings Incentive Match PLan for Employees) IRA plans are available to businesses that have 100 or fewer employees.

You can roll over funds from one SIMPLE IRA to another SIMPLE IRA. However, you can make a tax-free rollover from a SIMPLE IRA to a different type of IRA only after participating in the SIMPLE IRA plan for at least two years. If you roll over the funds during the first two years, the IRS will charge you a 25% penalty.

SEP-IRA rollover rules

Simplified employee pension (SEP) IRAs are a way for business owners to contribute to their own retirement and their employees’ retirement savings. Each participant sets up a SEP-IRA for employer contributions. SEP-IRAs follow the same rollover rules as traditional IRAs.

457(b) rollover rules

Section 457(b) plans are similar to 401(k) plans, but they’re available to governmental agencies and some nonprofit organizations.

Participants can make a tax-free rollover from a 457(b) into a traditional IRA, SIMPLE IRA, SEP-IRA, 401(k), 403(b) plan or another 457(b) plan as long as the receiving plan accepts rollovers.

403(b) rollover rules

403(b) plans also are similar to 401(k) plans, but they’re for employees of public schools and nonprofit organizations.

Participants can make tax-free rollovers from a 403(b) into a traditional IRAs, SIMPLE IRA, SEP-IRA, 457(b), 401(k) and other 403(b) plans as long as the receiving plan accepts rollovers.

401(k) to IRA rollover rules

An IRA allows rollovers from almost any type of retirement plan, including employer-sponsored 401(k) plans. Exceptions include:

• Required minimum distributions (the minimum withdrawal required after age 70½)
• Hardship distributions (withdrawals that fall under the IRS’s definition of “immediate and heavy financial need” for the employee, which can include the needs of the spouse, nonspouse, dependent or nondependent beneficiary of the employee)
• Loans from the 401(k) that are treated as distributions
• Distributions of excess contributions and related earnings
• Distributions to pay for accident, health or life insurance
• Withdrawals opting out of automatic contribution arrangements
• Distributions in a series of substantially equal payments
• Dividends on employer securities
• S corporation allocations that are treated as deemed distributions.

The below chart from the IRS summarizes rollover rules for different types of retirement accounts.

Green boxes indicate that an individual may roll over any part of the IRA once every 12 months tax-free in this type of transfer. Red boxes indicate that although a rollover might be allowed, it will be a taxable transaction.

ROLL TO

Special rules also apply to other types of IRA rollover situations.

Inherited IRA rollover rules

People often leave their IRAs to spouses or other beneficiaries, and the IRS has specific rules for each situation depending on who inherits the account.

Rules for spouses: Spouses who inherit a traditional IRA have three options.

1. Designate yourself as the account owner, and treat it as your own IRA.
2. Roll the balance into a traditional IRA, 401(k), 403(b) or 457(b) plan.
3. Qualify yourself as the beneficiary of the plan rather than treat the IRA as your own.

If you receive a distribution from your deceased spouse’s IRA, you have 60 days to roll the distribution into your own IRA, as long as the distribution isn’t a required distribution.

Rules for other beneficiaries: If you inherit a traditional IRA from someone other than your spouse, you can’t treat it as your own by making contributions or rolling any amount in or out of the account. However, nonspouse beneficiaries can make trustee-to-trustee transfers if the new IRA is in the name of the deceased IRA for the benefit of the beneficiary.

Rollover mistakes to avoid

To avoid problems with your rollover, it’s best to do a trustee-to-trustee transfer or have the check made out to the custodian of your new account, rather than having the check issued to you. When the check is made payable to you, potential problems could arise.

• It might be tempting to keep the money.
• You could miss the 60-day rollover window.
• You might inadvertently make more than one rollover within 365 days.

Any of these scenarios could lead to additional taxes and early-withdrawal penalties.

Reporting rollovers on your tax return

Rollovers — even tax-free ones — have to be reported on your tax return. Typically, the plan trustee or custodian will issue a 1099-R reporting the rollover amount. If the rollover is tax-free, the amount rolled over should appear in Box 1, with a zero in Box 2a and a G in box 7.

Occasionally, plan custodians or trustees issue incorrect 1099-Rs that show a tax-free rollover as a taxable transaction, so review the form carefully. You can ask the trustee to send you a corrected 1099-R if it was issued incorrectly. You should discuss the rollover with your tax professional before they prepare your return to ensure the rollover is reported correctly.

The bottom line on IRA rollovers

Before you roll over your old retirement savings, consider all of your available options and the new account’s investment options and fees. The process for rolling funds into an IRA is relatively straightforward, but messing it up can have serious consequences — for your tax bill and your future retirement nest egg.