| If you are moving money from one IRA account to another, you may be able to avoid taxes and penalties on the withdrawal, if you move fast enough, and jump through a few hoops. That's why they call this act a rollover.
What’s a Rollover?
Basically, in a rollover, you
- Withdraw cash (or other assets such as stock, or mutual funds) from one qualified retirement plan or IRA account and
- Reinvest it (roll it over) in another qualified retirement plan or IRA account within a certain time limit (usually 60 days).
Rollovers usually occur when you leave your job and receive all the funds in your retirement plan account. The most common rollovers are the movement of money:
- From one IRA to another IRA of the same type (traditional IRA to traditional IRA, or Roth IRA to Roth IRA)
- From an employer's plan to a traditional IRA
- From one employer's plan to another employer's plan
- From an IRA to an employer's plan (this is new in 2002)
If you have your plan administrator transfer the money from your qualified retirement plan account directly to an IRA account or another qualified retirement plan that is a direct rollover.
How Do I Report Rollovers on my Tax Return?
That depends on what type of rollover you made and how you moved the money, either by yourself or through a plan administrator (a direct rollover).
Let's look at four common scenarios:
From IRA to IRA
Here you transfer funds from a traditional IRA to another traditional IRA, or from a Roth IRA to another Roth IRA. The way you make the transfer dictates how much work you will face when you do your taxes.
When you ask your bank or other IRA custodian to do a direct transfer from your IRA account to another IRA account, the IRS does not require your bank to issue a Form 1099-R, which means that you do not have to report this transaction on your tax return.
If you pull money out of one IRA account yourself, then redeposit the money into another IRA account within 60 days, you need to report the rollover to the IRS, even though you do not have to pay any taxes on it.
- The bank or custodian of the first IRA account issues you a Form 1099-R with the amount of the distribution shown in box 1. As long as you actually redeposit the entire amount into another IRA within the 60-day time limit, you pay no tax on this rollover.
- You report the amount from Form 1099-R box 1 on line 15a of Form 1040, then enter a zero on line 15b (the taxable amount).
- In the margin next to line 15, you write the word Rollover to signal to the IRS that these funds were in fact subject to a tax-free rollover.
- Keep documents proving that you deposited the money in another IRA within 60 days. You do not have to attach proof of the rollover to your return, but you should keep the documents in your records, in case the IRS has any questions about the rollover.
From Employer's Retirement Plan to a Traditional IRA
If you ask your employer to transfer your retirement plan account balance directly to an IRA account, when you leave your job, your employer's plan administrator will issue a Form 1099-R to you with the amount of the distribution in box 1 and a letter code G in box 7. This indicates to the IRS that you rolled the money in your retirement plan over to an IRA account. Even though this rollover is not taxed, you still need to report it on your tax return.
- Report the amount from Form 1099-R box 1 on line 15a of Form 1040.
- Enter a zero on line 15b (the taxable amount).
- In the margin next to line 15, write the word Rollover.
With a direct rollover, no tax is withheld from any part of the distribution that is paid directly to the trustee of the IRA (or other retirement plan).
If you receive a distribution from your employer's plan, your employer or plan administrator will withhold federal income taxes at a 20% rate even if you deposit (or intend to deposit) the entire amount of the distribution (not just the amount you received a check for, but an amount equal to the gross distribution amount before withholding) in the traditional IRA or other plan within the 60-day period. Your employer's plan administrator will issue you a Form 1099-R, but the code will be something other than G.
If any part of that distribution is paid to you, that part is subject to 20% federal income tax withholding and you wind up with a check containing 80% of your retirement money! If you deposit that 80%, guess what: you owe taxes on the other 20%, as if you had pocketed it yourself.
Be sure to hold on to the paperwork that proves that you actually rolled the funds over within 60 days in case the IRS inquires.
Example
You have $10,000 in your employer's retirement plan, and you leave your job. You request that the plan administrator issue you a check for the balance in your account. The plan administrator, however, must withhold 20% of your distribution as federal income taxes, so you receive a check for only $8,000. The other $2,000 is sent to the federal government just like your payroll withholding!
After the shock wears off, you open an IRA account within 60 days and deposit your $8,000 check in that account. You are still taxed on the $2,000 that was withheld from your distribution check! Why? That amount was not rolled over into an IRA account, so it is considered a taxable distribution to you.
The best thing to do in this case is to come up with another $2,000 on your own and deposit that amount into the IRA account within the 60-day period. This way, your entire $10,000 distribution is considered a tax-free rollover.
What about the $2,000 of your money that the government has? You will report this as withholding on your Form 1040, and if you are otherwise paid up tax-wise, you should get that back as a refund when you file your return.
Note: There is no withholding on distributions expected to be less than $200 for the year.
From One Employer Retirement Plan to Another
If you have money in a qualified retirement plan, such as a 401(k) plan, a 403(b) annuity, or a governmental 457 plan, you can roll over the distribution to any other such plan, if it is willing to take rollovers. Note: these plans are not required to accept rollovers; each plan has to choose whether or not to accommodate them. So check before you try.
Examples of qualified retirement plans: 401(k) plans, 403(b) annuities and governmental 457 plans.
If you have an administrator transfer money from one qualified retirement plan directly to another retirement plan, the first plan's administrator will issue a Form 1099-R to you with the amount of the distribution in box 1 and a letter code H in box 7. As with a transfer from a retirement plan to an IRA, you are required to report this rollover on your return.
- Report the amount from Form 1099-R box 1 on line 15a of Form 1040.
- Enter a zero on line 15b (the taxable amount).
- In the margin next to line 15, write the word Rollover.
If you made the transfer yourself (in other words, you took the money out of the first employer's retirement plan, then walked across the street and gave it to the second employer's retirement plan, within 60 days), you must report that rollover in the same way. Just be sure to hold onto the paperwork that proves you did this within the 60 day grace period.
No new employer? There is a third alternative if you're moving money from one employer's retirement plan to another employer's retirement plan: you can temporarily move the money to an IRA (called a conduit IRA) before moving it to another employer. You might do this if you don't find a new employer within the 60-day time limit. The catch: you can't mix any other money with those funds while they're in the holding IRA, which means that you shouldn't make any contributions to that conduit IRA.
If you inherited the account from a spouse, you may roll over distributions from the inherited account to a qualified plan, 403(b) annuity or a 457 plan in which you participate.
From IRA to Qualified Retirement Plan
You can now roll over distributions from an IRA to a qualified plan, 403(b) annuity or 457 plan, thanks to new tax laws taking effect in 2002. But these plans are not required to accept rollovers; each plan has to choose whether or not to accommodate them.
Are There Time Limits on Rollovers?
You must contribute rollover funds to the replacement plan (either an IRA or another employer's qualified retirement plan) by the 60th day after you receive the distribution from the first IRA or qualified plan. It is important that you meet this deadline.
If you miss the deadline:
- The distribution is taxable in the year you received the money (not at the end of the 60-day time limit), AND
- Money you contribute to a replacement IRA after that 60-day deadline is treated the same as a new IRA contribution, which means that it is subject to that year's limit.
Our advice? If you're moving any retirement funds other than IRA funds, do a direct trustee-to-trustee transfer. This way you avoid getting hit with federal income tax withholding of 20%.
Also, you cannot roll over an IRA account more than once every 12 months.
Can I Do a Partial Rollover?
Yes. Rolling over only part of the money in your retirement plan is called a partial rollover.
Example
Let's say you were terminated from your job and you have your old company send you your $8,000 in retirement savings. You needed $5,000 of that to live on while you were searching for a new job. You did manage to get the remaining $3,000 rolled over into your new employer's retirement plan within the 60-day time limit.
The $3,000 you were able to successfully move to another plan in this partial rollover remains a tax-free transfer of tax-deferred funds. This is your partial rollover amount.
The $5,000 you did not roll over is taxable according to whatever rules govern the taxation of your retirement income. Basically this means that you'll have to report the $5,000 on your income tax return. In addition, you'll probably get hit with a 10% early distribution penalty on that $5,000 if you receive the money before the minimum distribution age for your plan (normally age 59-1/2).
Let's say you were terminated from your job and you have your old company send you your $8,000 in retirement savings. You needed $5,000 of that to live on while you were searching for a new job. You did manage to get the remaining $3,000 rolled over into your new employer's retirement plan within the 60-day time limit.
The $3,000 you were able to successfully move to another plan in this partial rollover remains a tax-free transfer of tax-deferred funds. This is your partial rollover amount.
The $5,000 you did not roll over is taxable according to whatever rules govern the taxation of your retirement income. Basically this means that you'll have to report the $5,000 on your income tax return. In addition, you'll probably get hit with a 10% early distribution penalty on that $5,000 if you receive the money before the minimum distribution age for your plan (normally age 59-1/2).
What About Rollovers from a SIMPLE plan?
Rollovers involving SIMPLE plans are generally the same as rollovers from regular IRAs as long as the rollover occurs within two years after a contribution was first made to the SIMPLE IRA. During this two-year period, distributions can be rolled over only to another SIMPLE IRA.
If the amount you take out of a SIMPLE plan is deposited into a traditional IRA account within this two-year period, the distribution is not a tax-free distribution and the deposit into the traditional IRA is not a rollover contribution. What does this mean? You are subject to tax on the distribution amount, and your contribution to the traditional IRA may be subject to limitations based on your adjusted gross income.
After the expiration of the two-year period, you can roll over or transfer distributions from a SIMPLE IRA to a traditional IRA tax-free, or convert the SIMPLE IRA to a Roth IRA.
As with traditional IRA accounts, you cannot roll over SIMPLE IRAs more than once every 12 months.
What About After-Tax Contributions?
Most contributions are pre-tax. Your can contribute right up to the plan's limit, deducting all that money from your income before you pay taxes. Pre-tax, or deductible contributions, can generally be rolled over, following the rules.
But with some plans and IRAs you can also put in additional money. Now, because these contributions are not tax deductible, you pay taxes on the money, so it is often called after-tax money. Those contributions may or may not be rolled over, depending on complicated new rules that went into effect in 2002.
Generally, employee after-tax contributions may be rolled over into another qualified plan or into a traditional IRA, except:
- if the rollover is from one qualified plan into another qualified plan, the rollover is permitted only through a direct rollover.
- a qualified plan can only accept rollovers of after-tax contributions if that plan provides separate accounting for those contributions and the earnings that will accumulate on those contributions.
After-tax contributions and nondeductible contributions to a regular IRA still can't be rolled over from the IRA to a qualified plan, 403(b) annuity or 457 plan.
What’s Best to Do?
Before you consider moving money from one retirement plan or IRA to another, think carefully about how you're going to handle the transfer.
The best way to accomplish such a transfer is a simple, direct trustee-to-trustee transfer of funds. Talk to your present plan's administrator for information regarding policies and procedures involving transfers of your retirement funds directly to other accounts.
If you do handle a rollover yourself, be sure to complete the movement of funds in the 60-day period.
If you're under age 59-1/2 and you don't complete the transfer in the required period of time, you will be taxed on the funds you removed, and you may also be subject to a 10% penalty for a premature retirement distribution.
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