Ensuring A Smooth, Smart IRA Rollover
When retirement finally beckons and you begin to tap the funds in your 401(k) or other retirement plan, you can expect to give the IRS its share—at ordinary income tax rates as high as 39.6%. But if you don’t need the cash immediately, a better option may be to transfer the money to an individual retirement plan, or IRA.
A properly executed rollover to an IRA postpones current tax on the funds you transfer and keeps the money growing tax-deferred. (You can do this when changing employers as well as at retirement.) Eventually, you must make taxable withdrawals, but not until the year after the year in which you turn age 70½. It’s also possible to transfer money from an existing IRA to another IRA, to get a better menu of investments, say, or to consolidate accounts.
Though making a successful rollover isn’t difficult, several pitfalls could lead to unnecessary taxes. Avoid these six common mistakes.
1. Not meeting the rollover deadline. The tax law requires you to complete a rollover within 60 days of receiving funds from your cashed-out retirement plan. Otherwise, the distribution is fully taxable on the current year’s return, and you could face a 10% penalty for a premature withdrawal if you’re under age 59½. That could get pretty expensive—50% or more of the value of your account when you consider federal and state taxes along with the 10% federal penalty and possible state penalties.
2. Not arranging a trustee-to-trustee transfer. Unless you make other arrangements, your company’s retirement plan administrator will impose 20% income tax withholding on a payout, even if you intend to meet the 60-day deadline. Though you may recoup the money when you file your taxes, you’ll have to come up with the cash before then to complete a tax-free rollover. To avoid the issue, instruct your plan to send funds directly to the new IRA.
3. Not rolling over sufficient funds. If you don’t use a trustee-to-trustee transfer—say, you need to use the funds for 60 days—you must deposit the exact amount in the IRA that you received as a distribution. Any shortfall is subject to tax (plus a possible early withdrawal penalty).
4. Making this an all-or-nothing proposition. You don’t have to roll over your entire retirement account balance. If you need cash now, you could take a partial taxable distribution and transfer the rest to your IRA. Alternatively, to better manage the tax implications, you could transfer the entire amount and do a separate distribution from the IRA.
5. Rolling over to the wrong IRA. You can make a tax-free rollover only to an IRA you own. Mistakenly transfer the funds to your spouse’s IRA or another account, and the distribution is taxable.
6. Making too many rollovers. A “rollover” is when you take possession of the funds before re-depositing them in an IRA. While you are allowed multiple “transfers” per year, you are only allowed one “rollover.” A subsequent rollover within the same year will be treated as a taxable distribution.
If you’d like our help in arranging a safe, tax-free rollover or transfer to an IRA, please give us a call.
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