Rollover (IRA p4)

When and individual leaves an employer where they had participated in the employer-sponsored retirement plan, like a 401k the individual often must decide the next steps for the retirement funds. One option is to roll over the funds to either Traditional IRA or Roth IRA.

The qualified retirement plan is an employer sponsored plan that meet specific internal revenue code requirements. Qualify retirement plans allow participants to set aside a portion of their wages in a tax deferred account. Examples include 401k and 403b plans and the Thrift Savings Plan.

A rollover distribution avoids taxation and allows funds to continue to grow tax deferred. There are variety of reasons for an individual to roll over or move funds from a qualified retirement plan to a IRA.

1. Former employer requires the retirement account to be closed.

2. Consolidate multiple retirement accounts.

3. More desirable investment choices, lower fees, etc

Direct and indirect rollover

A rolled over can be completed in two ways: direct and indirect.

A direct rollover, also known as a fund to fund transfer, involves moving funds directly from a qualified retirement plan to a new IRA trustee without withholding any income tax. Many tax expert recommend using a direct rollover whenever possible.

Indirect rollovers

funds in the plan are paid directly to the owner, giving the owner 60 days to deposit the funds into an IRA or another qualified plan.

• If the owner fails to deposit the funds within 60 days, the funds are treated as a taxable distribution.

• The IRS May waive the 60 day requirement in certain situations.

When a distribution is made, a mandatory 20% is withheld from the distribution for federal income tax.

This means the distribution is 20% less than what the owner will need to roll over, and the owner will need to use other funds to make up the amount withheld to qualify for a four rollover.

Ex. Paul takes a $2,000 distribution from his qualified retirement plan.

The trustee issues him of $1,600 check.

The distribution reflects 20%($400); withholding for federal income tax

If Paul only deposits the $1,600 received, the $400 will be treated as a distribution and taxed.

To avoid this, Paul must deposit the entire $200 as a rollover to an IRA or another qualified plan within 60 days.

To prevent the distribution from being included in taxable income, he will need to fund the 20% amount to qualify for the rollover.

A roll over to a traditional IRA isn't included as taxable income but it still must be reported on form 1099 R and the tax return.

I roll over to a Roth IRA is included in taxable income, but it's not subject to the 10% early distribution penalty.