It’s my annual “Taxes from A to Z” series! If you’re wondering whether you can claim wardrobe expenses or whether to deduct a capital loss, you won’t want to miss it.
E is for Eligible Rollover Distributions.
An eligible rollover distribution is exactly what it says on the tin: a distribution that can be rolled over to you as the participant, or to your spouse beneficiary, spouse (or former spouse) alternate payee, or designated non-spouse beneficiary paid in a lump-sum payment or a series of installments over a period of fewer than ten years. Eligible rollover distributions can be transferred, without taxation, from a 401(k) plan into another tax-advantaged retirement plan or individual retirement account (IRA).
Why would you want to roll over a distribution? Easy. When you roll over a retirement plan distribution, you typically don’t pay tax until you make a withdrawal. In that way, the money continues to grow tax-deferred (not tax-free). In contrast, if you don’t roll over a retirement plan distribution, you will pay tax on the amounts that have not already been taxed, and you may also be subject to a 10% additional tax on early distributions.
Often, distributions that you might rollover are tied to a specific event like changing jobs or the death of a spouse. For pre-retirement payments, you can perform a rollover as follows:
- Direct rollover. With a direct rollover, a distribution from a retirement plan is paid directly to another retirement plan or to an IRA, often by check made payable to the new account. No taxes are typically withheld on this distribution. (For a designated non-spouse beneficiary, the direct rollover is available only to an IRA, not to another plan.)
- Trustee-to-trustee transfer. With a trustee-to-trustee transfer, a distribution from an IRA is paid directly to another IRA or retirement plan. No taxes are typically withheld on this distribution.
- 60-day rollover. This is the most heart-stopping of all of the rollovers. With a 60-day rollover, the distribution from an IRA or retirement plan is paid out directly to you, most commonly by check made payable to you. If within 60 days, you deposit any or all of those funds into another qualifying IRA or retirement amount, that amount is not taxable (although taxes may be withheld on the distribution). If you miss that window, the entire amount is subject to tax and possibly, an extra penalty for early distributions (a waiver may be available in some circumstances).
It used to be the rule that could not make more than one rollover from the same IRA within a one year period. You also could not make a rollover during this one-year period from the IRA to which the distribution was rolled over. As of 2015, you can make only one rollover from an IRA to another IRA in any one year period, regardless of the number of IRAs you own (including SEP and SIMPLE IRAs, traditional and Roth IRAs). That restriction does not apply to Roth conversions, trustee-to-trustee transfers, IRA-to-plan rollovers, plan-to-IRA rollovers and plan-to-plan rollovers.
There are some additional restrictions on what you may rollover:
- You can rollover all or part of any distribution from your IRA except a required minimum distribution (RMD) or a distribution of excess contributions and related earnings.
- With respect to other retirement plan accounts, like your 401(k) plan, the same exceptions for RMDs and distributions of excess contributions and related earnings apply. Additionally, you cannot roll over loans treated as a distribution; hardship distributions; a distribution that is one of a series of substantially equal payments; withdrawals electing out of automatic contribution arrangements; distributions to pay for accident, health or life insurance, dividends on employer securities; or S corporation allocations treated as deemed distributions.
Not all plans are equal, however. You can’t just roll one plan over to another. Here’s a handy chart to help you figure which plans can be rolled to other plans:
It’s important to note that there are still restrictions within these plans. For example, some rollovers are subject to timing and still others may be taxable (such as, for example, rolling a traditional IRA to a Roth IRA). The rules governing to rollovers are super technical. If you’re thinking about making a rollover, consult with your financial advisor and your tax advisor to make sure that you get all the details right before you make a move.
For more Taxes A to Z, check out: