If moving your retirement funds around makes you a little nervous, that's normal. With many retirement plans, including Individual Retirement Accounts (IRAs) and employee-sponsored 401(k)s, you could end up paying unexpected penalties and additional taxes if you're not careful. Understanding a few basic rules and consulting with a tax professional can help you avoid costly mistakes.
What is a rollover?
A rollover lets you move funds from one retirement account to a different type of retirement account. For instance, maybe you want to move a prior employee-sponsored 401(k) to an IRA. Rollovers allow you to maintain your retirement assets' tax-deferred status without paying taxes or early withdrawal penalties when you transfer the money.
Read more: Choosing between a Roth IRA and traditional IRA? Know the differences.
Know the difference between transfers, rollovers and conversions
Transfer: Occurs between retirement accounts of the same type (for instance, an IRA at one bank to an IRA at another bank)
Rollover: Occurs between two different types of retirement accounts (from your 401(k) plan to an IRA)
Conversion: Occurs when you move money from a traditional IRA into a Roth IRA
The IRS treats each of these differently for tax purposes. Note that when you move funds from a tax-deferred account (a 401(k) or IRA) to a Roth IRA, you’ll be required to pay taxes on them, since Roth IRA contributions are after tax.
60-day rollover rules
With an indirect rollover, the original custodian sends you a check for the total amount you’re withdrawing. You have 60 days to roll it over to your new financial institution. The money must be in the new account no later than 60 days from when it was withdrawn from the original retirement account. If you don't deposit the full amount into the new retirement account, you’ll pay an early withdrawal penalty and income tax on that amount.
Save yourself the step of sending the funds yourself by having the rollover go directly to another retirement plan or IRA:
Direct rollover: Ask your plan administrator to make the payment directly to another retirement plan or IRA. The administrator may issue your distribution as a check payable to your new account.
Trustee-to-trustee transfer: Ask the financial institution holding your IRA to make the payment directly from your IRA to another IRA or retirement plan.
One-rollover-per-year rule
As an IRA owner, you can only make one 60-day indirect rollover per one-year period. There are a few exceptions, outlined on the IRS website. If you go over the one-rollover-per-year limit, there might be a 10% early distribution penalty if you’re under 59½ or a tax penalty for making excess contributions to your IRA.
When you roll over a retirement plan distribution, you generally don't pay tax on it until you withdraw money from your new plan. If you don't roll over your payment, it will be taxable as ordinary income, except for any portion that was after-tax or nondeductible contributions.
How to roll over funds
A direct rollover may be more streamlined than an indirect. Here are the general steps:
Contact your former employer’s plan administrator to ask for a direct rollover
Complete the required forms
Ask for your account balance to be sent to your new retirement account provider
Read more: How to rollover your 401(k) to an IRA
Is there a limit to how much you can roll over?
There is no limit on the amount you can roll over into an IRA. A rollover will also not affect your annual IRA contribution limit.
Common rollover mistakes to avoid
Missing the 60-day window: Not completing a 60-day rollover on time can result in your money being taxed as income and subject to a 10% early withdrawal penalty. Your workplace plan administrator can withhold 20% of your account and send it to the IRS as a federal income tax prepayment on the distribution.
Rolling over before taking a required minimum distribution (RMD): This affects those 73 or older who are required to take an RMD for the year. Doing so would result in an excess contribution, subject to an annual 6% penalty until corrected.
Withdrawing instead of rolling over: If you choose to withdraw instead of rolling over to a retirement account, you may lose money due to tax penalties.
Ready for rollovers
Rollovers don’t have to be complicated, but it’s okay to be nervous about it. With these rollover steps and mistakes in mind, you can move forward with more confidence if you choose to go down the rollover route.
