By Bob Palechek, CPA | April 3, 2020
You own your retirement funds. That grants you some flexibility in what you do with the funds and where you put them. But with flexibility comes responsibility, and you are responsible for following all of the IRS’s rules.
You may get help from plan custodians, administrators, or bankers, but that does not relieve you of the responsibility of getting it right. And a word of caution: many actions cannot be undone.
You may decide to move your retirement funds (1) between plan types, (2) to new accounts, or (3) to a new holder or custodian of your assets. If so, your goal is generally to achieve this without creating a taxable event and, done correctly, that should be achievable.
Our goal is to provide you with that knowledge. Or to show why you might want to consult with a tax pro before you start.
Transfers versus Rollovers
The transfer process is relatively straightforward. The rollover process is more complicated. Let’s look at both.
A transfer is typically done between IRAs. You let your new IRA know of your wish for it to ‘receive funds’ from another IRA, and you provide all the details of your original IRA. The new IRA will pull the funds across. No taxes are withheld, and you receive no funds. It is a safe and easy way to transfer retirement funds. You do not need to report a direct transfer on the IRS’s Form 1099-R, so you shouldn’t be alarmed if you don’t receive one.
All movements of funds that do not qualify as transfers are considered rollovers. And, they are more open to having something go wrong if not handled correctly.
Employer 401(k)-related rollovers
A typical rollover occurs when you reach out to your employer 401(k) plan and request all or a portion of that money. This may occur through an in-service withdrawal (if the employer plan allows it) or after departing from that employer.
- If you want to preserve your funds in a retirement account, you will request a rollover and provide the name of the new qualified plan or IRA account. The original holder of the funds will issue a direct payment to the plan or account electronically, if available, or via check. No taxes need to be withheld. You will receive a Form 1099-R to use when reporting the rollover on your taxes. The distribution amount is shown in Box 1, but none of the amount should be taxable, and the code in Box 7 will be a ‘G.’ All is good.
- If you receive a check to deliver to the new custodian, you will want the check to be payable to the new custodian, and not to you personally. That way, this will be considered a direct rollover, and no tax withholdings are required. The same reporting of the Form 1099-R will occur.
- If you receive the check payable to you, a 20-percent federal withholding is required. If your goal is a tax-free transaction, you have 60 days from the ‘constructive receipt’ of the check to deposit it into the new qualified plan or IRA account. (‘Constructive receipt’ is when you have reasonable access to possession of a check.)
- If you should miss the 60-day window to deposit, the distribution will be taxable to you and may be subject to a 10-percent penalty if you are below age 59½. There are no exceptions. If the 60-day window is missed because of cause, the IRS does provide a relief process but only under strict circumstances. It should not be relied upon if the deadline was accidentally missed or if you changed your mind.
To remedy the situation and to achieve a complete tax-free rollover in these circumstances, you will have to make up the 20-percent withholdings with other funds. You will be able to recover the 20-percent withholdings when you file your taxes the following year if you are overpaid.
IRA-to-IRA or Roth-to-Roth rollovers
The other typical rollover is from one traditional IRA to another, or from Roth to Roth. These rollovers can either be direct (where the check is made payable to the new custodian or IRA) or indirect (where the check is made payable to you). The first option is preferred because the 60-day window rule is not an issue.
- On indirect rollovers of a traditional IRA, a 10-percent federal withholding rule is standard but not mandatory. As in the remedy described above, the 10-percent withholdings would have to be made up with other funds to achieve a tax-free rollover.
- One inconvenience of the indirect rollover of traditional or Roth IRAs is that you are only allowed one rollover per year. The rule that introduced that limitation in 2015 exempted rollovers from 401(k)s.
- If you do an indirect rollover, it will generate a Form 1099-R to use when reporting the rollover on your taxes. Since an indirect rollover is where the check is received by you and payable to you, the Form 1099-R will come with a taxable distribution code on the form. The code in Box 7 will typically be a ‘1’ or ‘7.’ However, the issuer has no way of knowing your intentions. It also does not know if you met the 60-day window rule or the once-per-year rule.
- If you have someone preparing your taxes, make sure to provide them with all the details of your rollovers so you will not get taxed as though you took the money from your plan.
And if you would like help to ensure that you have followed all the rules, make sure to reach out to your tax professional. It’s always a good idea to make sure your T’s are crossed and your I’s dotted.