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Rollovers to IRAs - Rules, Tips and Cautions
by Robert D. Cavanaugh, CLU
Rollovers can be a confusing subject. This is because rollovers can come from
qualified plans, tax sheltered annuities, eligible Section 457 government plans
and the five types of IRAs.
Here, I will focus on rollovers that come from qualified plans such as 401(k),
pension and profit sharing plans. The rollover will be to a traditional IRA or
Roth IRA. Confining the explanation to a common rollover scenario keeps it
simple by eliminating a discussion of the many other rollover situations.
You have worked hard, built up a big 401(k) and are ready to retire. Your plan
is to roll your 401(k) into an IRA. What are the rules? What are your choices?
What are the cautions?
The Rules
The transfer of assets from your 401(k) to an IRA must be completed within 60
days. Failure to do so within this time frame would treat your intended rollover
as a distribution. This would subject it to taxation and, if you are under age
59 1/2, a 10 percent premature distribution penalty.
If you are unfortunate enough to have your plan assets invested in an
institution in bankruptcy, the IRS will cut you some slack. While your money is
frozen, the 60 day clock isn't running. While this may not come into play very
often, it's reassuring to know.
The cleanest way to do the rollover is to do a trustee-to-trustee transfer. If
you receive the qualified plan proceeds personally, 20 percent withholding is required.
Your Choices
Until 2008, you only have two IRA choices to accept your qualified plan
rollover: A traditional IRA or a SEP IRA. You can't roll it over to a Roth IRA.
The Pension Protection Act of 2006 provides that rollovers from qualified plans
can be rolled over to a Roth IRA starting after 2007. Until then, there is a
work-around. You will need to roll your plan assets over to either a traditional
IRA or SEP IRA and then roll that into a Roth IRA. In any case, remember that
when the assets are rolled into a Roth IRA, they are taxable.
The best timing of a rollover can be a function of several things. A number of
people would prefer not to take the required minimum distributions (RMDs) beginning
at age 70 1/2. Here's a way to defer that requirement or eliminate it altogether.
If you continue to work, you don't have to start taking RMDs until you retire.
If that is later than your age 70 1/2, you have followed the rule that says RMDs
start at the later of retirement or age 70 1/2 and accomplished your postponement goal.
While you would have to pay tax on a rollover that eventually winds up in a Roth
IRA, distributions from Roth IRAs aren't required until your death. If your spouse
makes the election to treat your Roth IRA as his or her own, distributions are not
even required until your spouse's death.
If these facts match your circumstances and objectives, you will want to wait to
do your rollover until you actually retire.
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