When you take money or property out of a retirement account before the rules allow it, your withdrawal is typically subject to ordinary income tax plus an early withdrawal penalty.
However, when you want to transfer your retirement assets into another qualified plan there’s a simple way to do it, that doesn’t trigger any taxes or penalties, called a Rollover IRA.
Keep reading to learn about the different types of rollovers, the right way to make them, and the rules you must follow to stay out of trouble.
Types of Retirement Rollovers
The most common type of IRA rollover occurs when an employee leaves a company and wants to take their retirement money with them, instead of leaving it in their old workplace plan.
You’re permitted to roll over amounts from the following types of retirement plans into a Traditional IRA on a tax-free basis:
• Pre-tax qualified plans, including a 401(k)
• Pre-tax 403(b)
• Pre-tax 457(b)
• SIMPLE IRA (a rollover can be made after 2 years)
• Traditional IRA
You can also roll over amounts from the following types of plans into a Roth IRA on a tax-free basis:
• Roth qualified plans, including a 401(k)
• Roth 403(b)
• Roth 457(b)
• Roth IRA
However, Rollover IRAs from any type of pre-tax retirement account into any type of Roth account must be included in your taxable income in the year of the distribution. That’s because contributions to a Roth account are always made on an after-tax basis.
Additionally, you may be able to roll over tax-free distributions from a traditional IRA into various types of pre-tax qualified workplace plans (except SIMPLE IRAs), if the plan document allows it.
Retirement Distributions That Are Ineligible for a Rollover IRA
Not all distributions from a retirement account can be rolled-over. You’re prohibited from doing a rollover on all or part of the following:
• A required minimum distribution
• A hardship distribution
• Substantially equal periodic distributions based on your life expectancy, or the joint life expectancy of you and your beneficiary, or paid over a period of 10 years or more
• A corrective distribution of excess contributions or allocable investment gains
• A loan distribution
• Dividends on employer securities
• The cost of life insurance coverage
How to Make a Retirement IRA Rollover
To make an IRA Rollover, simply submit a request form through your online brokerage account or by requesting one from your account custodian or benefits administrator at work.
There are 2 options for receiving your rollover distribution:
1. Receive a payment in your name: You can have a check for your rollover funds made payable to you. Then you make a payment to the new retirement account.
When rolling-over funds from an employer plan, this option requires that the payer withhold 20% of any taxable amount—even if you plan to make a rollover contribution later.
For example, if you want to roll over $20,000 from your 401(k), the custodian must deduct $4,000 ($20,000 x 20%) and pay you the remaining balance of $16,000.
If you complete the rollover, your withholding will be refunded when you file your tax return (assuming you don’t owe tax in excess of the withholding amount). However, it could take many months to receive your tax refund and you lose out on potential investment gains every day that the money is not under your control.
You can add funds from other sources to equal the amount withheld. For instance, if you have $4,000 in a savings account, you can deposit those funds in your retirement account to replace the missing amount of rollover tax withholding.
2. Receive a direct rollover: You can have a check for your rollover funds made payable directly to your new retirement account. Be sure you know exactly how the check should be written so it will be accepted by the account custodian. You receive the check and then forward it to the new account.
Making a direct rollover is always the best option because you avoid having any tax withheld.
At the end of the year, you’ll receive Form 1099-R or Form 5498 from your account custodian to document the rollover. You can’t deduct a rollover contribution from your taxable income, but you still must report it on your tax return.
What is the IRA Rollover Time Limit?
The most important rule to remember about retirement rollovers is that you must make the contribution to the new account within 60 days after you receive a distribution from the old account. There’s no extension of time for weekends or holidays.
If you miss this important 60-day deadline, your distribution is treated as a taxable event (except for after-tax amounts) and also may be subject to an additional 10% early withdrawal penalty if you’re younger than age 59½. Distributions from a SIMPLE IRA within the first 2 years of participation will be subject to a higher penalty of 25% additional tax.
Here’s an example: You leave your job and decide to roll over your 401(k) retirement account into a traditional IRA. You receive the distribution on December 1, 2012. In order to avoid having to pay tax on the distribution in 2012, you must deposit the funds into your traditional IRA on or before January 30, 2013, the 60th day following December 1.
What is the IRA Rollover Waiting Period?
Another rule to be aware of applies when you roll over any amount from one traditional IRA into another traditional IRA. You must wait one year from the distribution date before you can make another IRA Rollover from that same account. Additionally, during the one-year waiting period, you generally can’t make a rollover from the IRA into which you contributed the rollover funds.
This waiting period rule doesn’t apply when you roll over any amount from an employer plan. You can make more than one distribution from the same workplace plan within a year.
Note that the waiting rule doesn’t apply when funds in your traditional IRA are transferred from trustee to trustee, without being distributed to you. No matter if that occurs at the trustee’s request or yours, a trustee-to-trustee transfer isn’t the same as a rollover and therefore doesn’t subject you to the one year waiting period.
What Types of Assets Can You Rollover?
If you have a mix of assets in your retirement account—such as cash and property—you can roll over part or all of it, in any combination that you choose. However, you may not substitute one type of asset for another.
For example, if you receive real estate from an eligible Rollover IRA distribution, you can sell all or a part of it and roll over the proceeds from the sale into a retirement account. But you’re prohibited from keeping the property and substituting your own cash for it. You must roll over the exact same property or sell it and roll over the cash proceeds.
Converting a Traditional IRA into a Roth IRA
When you roll over all a portion of a traditional IRA into a Roth IRA, it’s a special kind of transaction called a conversion contribution. There’s no restriction on your income to make a Roth conversion; however, there is an annual income limit for making contributions to a Roth IRA each tax year.
As I mentioned, you must pay income tax on any amount you convert from a traditional IRA to a Roth IRA that wasn’t previously taxed. But you avoid the 10% additional penalty for early distributions if you roll over the funds within the 60-day time limit.
Why You Should Make a Retirement Rollover
Instead of cashing out an old retirement account and paying unnecessary taxes and penalties, use a rollover to move your money into a new account. A rollover is easy to complete and allows you to continue making tax-advantaged contributions, so you build your retirement nest egg as quickly as possible.