IRA Rollovers: Moving Retirement Funds

Moving IRA money from one institution to another is not uncommon. A transfer is moving funds from one IRA trustee or custodian, such as a bank or brokerage account, to another. The funds are not paid directly to you, and the transfer occurs without the funds being placed in a non-IRA account. Transferring IRA funds is tax-free.

A rollover is a distribution of assets from one retirement plan that you then contribute to a different retirement plan. There are two types of rollovers. With a direct rollover, money is transferred directly from the employer retirement plan to a Traditional IRA. You do not receive a check, and no money is withheld for payment of taxes. With a regularrollover, you receive plan assets, minus 20% withheld for taxes. To avoid current taxes and to continue to benefit from tax-deferred compounding, you must reinvest the full value of the distribution in an IRA or other employer’s plan within 60 days of receiving the money. However, this law will change in 2002, if there are cases when this regulation violates equity and good conscience. When you file taxes, a credit is received for the amount withheld against taxes owed.

Under tax laws that remain in effect for 2001, if you leave your current job, you must leave the balance of your account in the company’s retirement plan. However, the new tax laws have included changes for the portability of retirement accounts. Beginning in the year 2002, qualified pension plans such as 401(k) plans, 403(b) plans, and 457 plans can be rolled-over into an IRA or into each other. Only a Traditional IRA can be used for rollover contributions from employer plans; you may not rollover contributions to a Roth IRA. However, you can roll retirement assets into a Traditional IRA and then convert all or a portion of the Traditional IRA to a Roth IRA; nevertheless, be sure to consult with your financial adviser first..

Before an IRA can be rolled over, an eligible rollover distribution must NOT be

• a required minimum distribution
• a series of equal periodic payments for a period of 10 years or more (section 72 (t) payments)
• distributions to beneficiaries of a plan, except one’s spouse

In addition, a 403(b), 401(k), and 457 plan cannot be rolled-over to an IRA if the above three distributions occur or if the following distributions apply:

• distributions due to hardship
• distributions to correct excessive contributions
• loans treated as distributions
• dividends on employer securities
• cost of life insurance

After-tax funds in qualified plans will be allowed to be transferred to an IRA under the new regulations. It must be noted, however, that when this happens, it cannot be withdrawn tax-free. This is due to the Pro Rata Rule, which requires every IRA withdrawal to consist of a proportionate amount of the taxable and nontaxable (basis) amounts in the IRA.

As an example, Ed Slott, from Financial Planning, September 2001, explains “…assume you have $100,000 in an IRA, of which $20,000 is basis (the total of nondeductible contributions made over the years). In 2002, you roll over $200,000 from your plan to the IRA, of which $10,000 is from the after-tax contributions. After the rollover you have $300,000 in your IRA, of which $30,000 is basis (the $20,000 nondeductible plus the $10,000 of after-tax funds rolled into the IRA). Now you need money and want to withdraw the $10,000 of after-tax money from the plan that is now in the IRA, figuring it will all be tax-free. It won’t. Only $1000 of the withdrawal will be tax free. You’ll pay tax on the other $9.000. The Pro Rata Rule requires each withdrawal to contain a proportionate amount of both taxable and nontaxable funds. In this example, the nontaxable amount in the IRA is $30,000, which is 10% of the $300,000 IRA balance after the rollover. This means that each withdrawal will be 10% tax-free and 90% taxable.”

The options allowed by portability of your retirement plan funds have advantages and disadvantages:

Option 1: Transfer to a new employer’s retirement plan
Advantages
· Tax-deferred compounding
· Avoid current taxes
· If under age 59 ½, avoid 10% premature distribution penalty

Disadvantages
· Possibility of inadequate investment choices in new employer's plan
· Possibility of higher fees in new employer's plan

Option 2: Rollover to a Traditional IRA
Advantages:
· Tax-deferred compounding
· Avoid current taxes
· If under age 59 ½, avoid 10% premature distribution penalty
· If establishing a conduit IRA (an IRA that is not commingled with any other IRA assets), you may be able to roll the conduit IRA into a new employer’s retirement plan.

Option 3: Receive some or all of money now

Advantages
· Receive money immediately
· Distributions may qualify for 10-year forwarding averaging if you were born before 1936

Disadvantages
· 20% of distribution is automatically withheld
· If under age 59 ½ , may be subject to 10% early withdrawal penalty
· May be putting retirement at risk if not at retirement age