Understanding the IRA rollover rules

Whether you are changing jobs or retiring, it’s likely you’ve heard the terms rollover or transfer in regards to your qualified employer sponsored retirement plan or IRA. This process allows you to take your retirement assets from your previous employer and move them to your IRA while the money continues to remain tax-deferred. However, the rules vary depending on which method you choose. This fact sheet is designed to help you make an informed choice that best suits your particular needs.

Employer-sponsored plan to IRA direct rolloverA distribution eligible to be rolled over is taken from a qualified pension plan, employer sponsored plan such as a 401(k), 403(b), or Government 457 that is payable to the trustee, custodian, or issuer of the receiving IRA and is reported to the IRS as a rollover. There is no limit to the number of direct rollovers that can occur in a year. IRA owners will receive an IRS Form 1099-R (from the qualified plan) to report the distribution and an IRS Form 5498 (for the IRA) that reports the rollover.

Roll to a Traditional IRA You can generally have the eligible rollover amount transferred into an existing IRA, or you may prefer to set up a new Traditional IRA for it. After-tax contributions you have in your plan may also be rolled over to your Traditional IRA. IRS form 8606 is to be filed when rolling after-tax money into a Traditional IRA and the pro-rata rule applies when taking distributions from any of your Traditional, SEP, or SIMPLE IRAs.

Roll to a Roth IRA You could elect a direct rollover to a Roth IRA of any eligible distributions from an employer-sponsored retirement plan since there are no limits on Roth conversions. All taxpayers are able to convert regardless of their MAGI (modified adjusted gross income) or tax filing status. These conversions can be made through a direct rollover of before-tax and/or after-tax money from the plan to the Roth IRA. A Roth conversion of after tax amounts will not be taxable income. However, any pre-tax amount converted will be included in the IRA holder’s gross income for the year. Due to the complex nature of this strategy, seek advice from your tax advisor. Also, if you have a Roth account within your qualified plan, you may roll the Roth plan account to a Roth IRA without triggering taxes. These amounts cannot be rolled to a Traditional IRA.

Indirect rolloverAn indirect rollover occurs when you take a lump-sum distribution from your employer sponsored retirement plan, typically with a check payable to you instead of your IRA. Or, you may choose to roll over only part of your distribution and keep the rest. In either case, the plan is required to withhold a mandatory 20% for federal taxes on the amount distributed to you. Any taxable amount not rolled over, including the funds withheld for taxes, will be considered a taxable distribution included as income for the year. Additionally, you may owe a 10% penalty.

You can avoid this taxable event by rolling over, within 60 days, the total distribution amount (including withholding) by personally deposit (out of pocket) the 20% tax withholding that was deducted from your distribution. Any portion of the employer-sponsored retirement plan not rolled over, including the 20% withholding, will be considered a taxable distribution and income tax will be due on the taxable portion plus you may owe a 10% penalty.

IRA to IRA rolloversThis type of rollover is often called the 60-day rollover because an IRA owner can take a distribution from an IRA and roll it over to another IRA or to the same IRA within 60 days of receipt to avoid taxes (and penalties) on the distribution. The IRA owner is limited to rolling over one distribution from a particular IRA within 60 days, in any 365-day period. This limit is applied separately to each IRA you own. Due to the 365-day rule, you should be cautioned to take all the money needed at one time because you may only put one distribution back, per IRA, as a rollover contribution. After a rollover between IRAs has occurred, neither IRA can make a distribution eligible for rollover for the next 365 days. However, either IRA can receive rollovers from other IRAs.

You will receive a Form 1099-R to report the distribution and a Form 5498 to report the rollover. Remember that the Form 5498 is usually not mailed until after the tax filing deadline so you should keep the statements showing the rollover contribution. However, Form 5498 does not need to be attached to your tax return. The information is provided to the IRS by your IRA custodian or trustee. Be sure to carefully follow the IRS instructions for reporting these transactions.

Additional rulesIt is important to understand the additional rules regarding a 60-day rollover.

• The 60 days begin when you take constructive receipt of the distribution, not the date the check was issued.

• If the 60th day falls on a weekend or legal holiday, the rollover must be completed no later than the last business day immediately prior to the weekend or holiday.

• The once every 365-day rule does not apply to a rollover from a qualified employer-sponsored plan to an IRA. You can roll over more than one distribution from the same employer sponsored retirement plan within a year.

• The once every 365-day rule does not apply for a conversion to a Roth IRA.

• You do not have to take a full distribution of the IRA, as partial distributions are allowed.

Trustee to trustee IRA transfersA transfer allows you to direct the custodian of your IRA to transfer your assets directly to an IRA held at another financial institution. You are not in receipt of the funds, thus, there is no taxable event.

This type of transfer doesn’t count as a rollover, so you can make as many transfers as frequently as you want. There is no IRS reporting, so you will not receive IRS forms.

IRA transfers due to divorceIf an interest in an IRA is transferred by a divorce decree or separation agreement, the interest in the IRA can be transferred to the former spouse’s IRA. This transfer is not a taxable event to either party. This is a direct transfer so there is no tax reporting.

A Qualified Domestic Relations Order (QDRO) is the document required to transfer an asset from a divorcing party’s qualified plan to an IRA for their former spouse.

Roth IRA conversionsTraditional IRA ConversionConverting allows you to reposition your current tax-deferred Traditional, SEP and/or SIMPLE IRA (after two years from the first SIMPLE contribution) to a tax-free Roth IRA by paying ordinary income tax (but without the 10% penalty tax) on the taxable amount converted. Once the rollover to the Roth IRA is completed, you may be maximizing your potential earnings with tax-free growth.

Roth conversion from employer sponsored planAs previously discussed you can directly transfer your eligible employer sponsored plan rollover distribution to a Roth IRA. You could also execute an indirect rollover. If you receive a check, payable to you, from the plan of before and/or aftertax amounts you would have 60 days to roll that amount to the Roth IRA. Remember a Roth conversion of after tax amounts will not be taxable income. Any pre-tax amount converted will be included in the IRA holder’s gross income for the year. Due to the complex nature of this strategy, seek advice from your tax advisor.

60-day rollover hypothetical example

Travis Lee has two Traditional IRAs at our firm. IRA A has $75,000 and IRA B has $100,000. In March Travis takes a $15,000 distribution from IRA A. He rolls the $15,000 back into IRA A before the end of the 60-days. In October he needs $30,000. He takes $30,000 from IRA B and rolls that amount back within 60 days. He tells his financial professional in December he needs a distribution of $20,000 from one of his IRAs. His financial professional explains that while he can take a distribution from either IRA he is not eligible to roll over that distribution into any Traditional IRA. He would instead owe tax and perhaps a 10% penalty on the distribution. Note that if Travis had rolled the March distribution of $15,000 from IRA A into IRA B, the October distribution of $30,000 from IRA B would not be eligible to be rolled over.

Please note: This material has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The accuracy and completeness of this information is not guaranteed and is subject to change. It is based on current tax information and legislation as of August 2012. Since each investor’s situation is unique, you need to review your specific investment objectives, risk tolerance and liquidity needs with your financial professional(s) before a suitable investment strategy can be selected. Also, since our firm does not provide tax or legal advice, investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences.

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Traditional IRA distributions are taxed as ordinary income. Qualified Roth IRA distributions are not subject to state and local taxation in most states. Qualified Roth IRA distributions are also federally tax-free provided a Roth account has been open for at least five years and the owner has reached age 59½ or meets other requirements. Both may be subject to a 10% Federal tax penalty if distributions are taken prior to age 59½. Roth IRA conversions are not suitable for all investors.

NOT FDIC INSURED NOT BANK GUARANTEED MAY LOSE VALUEINVESTMENT AND INSURANCE PRODUCTS:

Coverdell Education Savings Account (ESA) to 529 Plan transfersYou can take money out of a Coverdell ESA as a distribution and put it in a 529 plan without paying tax because a contribution to a 529 plan is considered a qualified education expense, just like money that was spent for tuition or other costs of education. If you do this, you’ll have to follow the 529 plan rules if you want to distribute earnings tax-free; you won’t be able to use this money for primary or secondary education. The earnings “transfer over” to the 529 plan so they’ll be treated as earnings when money comes out of the 529 plan.

Please consider the investment objectives, risk, charges, and expenses carefully before investing in a 529 savings plan. The official statement, which contains this and other information, can be obtained by calling your financial advisor. Read it carefully before you invest. Investors should consider, before investing, whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s 529 college savings plan. The availability of such tax or other benefits may be conditioned on meeting certain requirements.

Talk to usWe hope these facts will help you in planning your IRA distributions and rollovers. If you have questions or want to learn more, please contact your financial professional. We look forward to working with you to help meet your financial goals.