If you have ever left a company, either voluntarily or involuntarily, you may have been too tied up to realize that you left your 401(k) in their system. While that isn't terrible, plenty of people do that all the time, it is helpful to consider moving that money into an account that you can directly control without any tax consequences.
For this edition of Macro Mondays, we're going to talk about the all important Rollover IRA and how it can be used to manage your old retirement savings from a previous employer. For more information, be sure to check out this information on Investopedia.
What is 'IRA Rollover'?
An Individual Retirement Arrangement (IRA) rollover is a transfer of funds from a retirement account into a traditional IRA or a Roth IRA. This can occur either through a direct transfer or by a check, which the custodian of the distributing account writes to the account holder who then deposits it into another IRA account. IRA rollovers can occur from a retirement account such as a 401(k) into an IRA, or as an IRA to IRA transfer. Most rollovers occur when people change jobs and wish to move 401(k) or 403(b) assets into an IRA, but some occur when account holders simply want to switch to an IRA with better benefits or investment choices.
How can I do an 'IRA Rollover'?
To engineer a direct roller over, an account holder needs to ask his plan administrator to draft a check and send it directly to the IRA. In IRA-to-IRA transfers, the trustee from one plan sends the rollover amount to the trustee from the other plan.
If an account holder receives a check from his existing IRA or retirement account, he can cash it and deposit the funds into his IRA by himself. However, he must complete the process within 60 days if he wants to avoid income taxes on the withdrawal. If he misses the 60-day deadline, the Internal Revenue Service treats the amount like an early distribution.
How do taxes play a role in the IRA Rollover?
In direct transfers, there are no taxes withheld. Rather, the entire amount transfers directly from one account to another. However, if the account holder receives a check which he personally deposits into his IRA, the IRS insists upon a withholding penalty. Custodians or trustees must withhold 10% on checks from IRA distributions and 20% on distributions from other retirement accounts, regardless of whether or not the funds are earmarked for a rollover. At tax time, this amount appears as tax paid by the tax filer.
However, if an account holder receives a distribution from a Roth IRA to rollover into a traditional IRA, he does not have to pay any taxes on the distribution or report it as income, as distributions from Roth IRAs are not taxed.
Are there special rules for the IRA-to-IRA Rollovers?
Yes. Many IRAs only allow one rollover per year on an IRA to IRA transfer. The one-year calendar runs from the time the distribution is made, and it does not apply to rollovers between traditional IRAs and Roth IRAs. Individuals who do not follow this rule may have to report extra IRA-to-IRA transfers as gross income in the tax year in which the rollover occurs.
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