Rollovers can be a confusing subject. This is because rollovers can come from qualified plans, tax sheltered annuities, eligible Section 457 government plans and the five types of IRAs.
Here, I will focus on rollovers that come from qualified plans such as 401(k), pension and profit sharing plans. The rollover will be to a traditional IRA or Roth IRA. Confining the explanation to a common rollover scenario keeps it simple by eliminating a discussion of the many other rollover situations.
You have worked hard, built up a big 401(k) and are ready to retire. Your plan is to roll your 401(k) into an IRA. What are the rules? What are your choices? What are the cautions?
The Rules
The transfer of assets from your 401(k) to an IRA must be completed within 60 days. Failure to do so within this time frame would treat your intended rollover as a distribution. This would subject it to taxation and, if you are under age 59 1/2, a 10% premature distribution penalty.
If you are unfortunate enough to have your plan assets invested in an institution in bankruptcy, the IRS will cut you some slack. While your money is frozen, the 60 day clock isn't running. While this may not come into play very often, it's reassuring to know.
The cleanest way to do the rollover is to do a trustee-to-trustee transfer. If you receive the qualified plan proceeds personally, 20% withholding is required.
Your Choices
Until 2008, you only have two IRA choices to accept your qualified plan rollover: A traditional IRA or a SEP IRA. You can't roll it over to a Roth IRA.
The Pension Protection Act of 2006 provides that rollovers from qualified plans can be rolled over to a Roth IRA starting after 2007. Until then, there is a work-around. You will need to roll your plan assets over to either a traditional IRA or SEP IRA and then roll that into a Roth IRA. In any case, remember that when the assets are rolled into a Roth IRA, they are taxable.
The best timing of a rollover can be a function of several things. A number of people would prefer not to take the required minimum distributions beginning at age 70 1/2. Here's a way to defer that requirement or eliminate it altogether.
If you continue to work, you don't have to start taking RMDs until you retire. If that is later than your age 70 1/2, you have followed the rule that says RMDs start at the later of retirement or age 70 1/2 and accomplished your postponement goal.
While you would have to pay tax on a rollover that eventually winds up in a Roth IRA, distributions from Roth IRAs aren't required until your death. If your spouse makes the election to treat your Roth IRA as his or her own, distributions are not even required until your spouse's death.
If these facts match your circumstances and objectives, you will want to wait to do your rollover until you actually retire.
The Cautions
There are certain things that cannot be rolled over from a qualified plan to an IRA. They are technical in nature and don't come up often. Examples would include hardship distributions from a 401(k) plan, loans that are deemed as distributions and required minimum distributions. Nevertheless, I would suggest seeking qualified tax advice prior to your rollover to make sure prohibitions do not exist.
One common limitation, however, is life insurance. If your qualified plan includes life insurance, this cannot be rolled over as IRAs cannot invest in life insurance.
This covers most of the common elements of rolling your qualified plan at work over to a traditional or Roth IRA. Armed with this working knowledge, be sure to sit down with your financial planner and accountant to make sure the transaction is done properly and matches your objectives.
Robert D. Cavanaugh, CLU is a 36 year financial and estate planning veteran and author of the free newsletter, "The Estate Preservation Advisor". To subscribe and get the free video, "How to Sell Your Life Insurance Policy for More Than the Cash Value", go to http://theestatepreservationadvisor.com/freevideo.htm
