Rolling over retirement savings from a former employer’s retirement plan to a self-directed IRA can have many benefits, including the freedom to invest in a broad range of alternative investments. Almost 60% of IRA-owning households have rollover assets in their IRAs.1 But the number one reason most people give for rolling their savings out of a workplace plan into an IRA is that they don’t want to leave their savings with a former employer.1 No matter how you feel about your former employer, don’t let your rush to cut ties negatively affect the retirement nest egg you’ve worked hard to accumulate. Understanding the tax rules for rollovers and what not to do can help you preserve – and continue growing – your retirement savings.
- Don’t cash out – beware the 10% early distribution tax.
It can be tempting to cash out your account rather than deal with the details to move it to a new account. But if you cash out, you’ll be taxed on the amount distributed from the plan (unless you have made after-tax or Roth contributions). And, if you’re under age 55 when you separate from your employer, you’ll pay an additional 10% early distribution tax as a penalty for cashing out your retirement savings before you retire. On top of the taxes, you’ll miss out on the chance to continue growing your savings for retirement.
- Don’t cash out – kiss 20% good-bye, at least for a while.
No matter your age when you take a distribution from a retirement plan, the plan must withhold 20% of the amount distributed if it is eligible to be rolled over but is paid directly to you instead. The plan will send the 20% to the IRS as a pre-payment of your tax liability on the distribution. You may get some or all of it back when you file your taxes for the year, but the IRS will hold on to it in the meantime. You must include that 20% in your taxable income for the year and it is subject to the 10% early distribution tax, even though you never received it.
- If you did cash out, you may still have an option to roll over.
If you have already requested a check payable to you from a former employer’s retirement plan, you may still be able to roll over your savings to an IRA. You can complete a rollover within 60 days after you receive the check. If you deposit 100% of the amount that was distributed from the plan, you will not be taxed on the distribution. This means you must come up with the cash to cover the 20% that was withheld and deposit it into the IRA with the rest of the distribution.
- Research your options before you request a distribution.
If you participate in a profit sharing plan, 401(k) plan, 403(b) plan or governmental 457(b) plan, you may roll over your savings to an IRA. Each IRA provider offers different support services and investment options, and charges fees for those options. Research providers to find the IRA custodian that handles the type of investments and services you want.
- Make sure your assets are eligible for rollover.
Most distributions from a workplace plan are eligible for rollover, but certain ones are not. If you are required to take a distribution each year because you were age 70½ or older by December 31, 2019, (or age 72 beginning January 1, 2020), you cannot roll over a required distribution. You must take the required minimum distribution (RMD) due in the current year first, then you can roll over the remainder of your account. You also cannot roll over an amount that is distributed as an excess contribution.
- Request a rollover by the tax status of your plan contributions.
Most retirement plan assets are not taxed until you withdraw them, including your salary deferrals, your employer’s contributions to your account, and any investment earnings in your account. But if you have after-tax or Roth contributions in your plan account, be sure to roll them to a Roth IRA to maintain their tax-free status. You can request that your employer’s plan split your rollover and send the pre-tax assets to a Traditional IRA and the after-tax and Roth assets to a Roth IRA.
- Understand any fees associated with distributions.
Whether you request a rollover or a distribution payable to yourself, most plan providers will charge a distribution fee. Ask ahead of time how much will be charged so you’re not surprised by the reduced amount you receive and you can verify that the correct amount was rolled over.
- Set up your IRA first.
Once you have chosen an IRA custodian to receive your rollover, set up an IRA (if you don’t already have one). You will need to know your IRA account number and the instructions for sending a check or transferring money to your IRA. If you accidentally roll over to a non-IRA account (e.g., a savings account), your retirement savings will lose the tax-deferred status and will be taxable to you in the current year, unless you catch and correct the error within 60 days.
- A direct rollover is safest.
Be sure to ask your former employer’s plan for a “direct rollover” to your IRA. There is no tax withholding with a direct rollover, and your assets should travel directly from your employer’s plan to your IRA.
- Ask for help.
IRA providers, the government, and even your former employer want retirement savings preserved for your retirement. Everyone involved in processing these transactions should be able to answer your questions and assist you in completing your rollover correctly.
For More Information
STRATA Trust would be happy to assist you in completing an IRA rollover. If you have any questions about rollovers or establishing a self-directed IRA, please contact us at 866-928-9394 or Service@StrataTrust.com.