Over the course of your career, you will most likely have several employers and several retirement accounts established. Rolling over a retirement account is a common transaction for individuals to make. However, costly mistakes during this process are common as well. If you are considering rolling over your retirement account, you will want to be aware of these common rollover mistakes to help avoid any unnecessary taxes and penalties.
Rollovers can be completed directly or indirectly, depending on which option is offered by your previous employer. With a direct rollover, the assets from your old retirement account is transferred straight to your new retirement account. In some instances, the employer will send you a check made out to the new custodian instead of sending the assets direct to the new custodian, this is still considered a direct rollover. An indirect rollover means that you receive custody of the assets that you want to roll into another retirement plan. The plan administrator liquidates the assets of the retirement plan you want to rollover and mails a check made payable to you or deposits the assets into your bank account.
Here are some common mistakes individuals make that can be avoided.
1) Missing the 60 day deadline.
With an indirect rollover, you receive custody of the assets you requested to be distributed. In order to avoid being taxed for this transaction, you must roll the assets into another retirement plan within 60 days. If you miss this cutoff time, the IRS characterizes the distribution as taxable income. Also, if you are under 59 ½ years old, you will have an additional 10% early withdrawal penalty from the IRS.
Important Notes:
If your old retirement fund had less than $1,000 in it when you left employment, the employer might send you a check automatically. If this is the case, you will want to open a new retirement fund quickly to invest the assets before the 60 day deadline.
With indirect rollovers from an employer-sponsored plan, such as a 401(k), the company must withhold 20% of the taxable amount and send that amount to the IRS, even if you intend to rollover the entire amount within 60 days. You will need to replace this 20% withheld with outside funds and then roll the entire amount of assets into another retirement plan within the 60 days. This money will be returned to you as a tax credit for the year when the rollover process is completed.
The IRS does not allow non-spouse beneficiaries to complete a 60-day rollover of inherited retirement plan assets. He or she must complete a direct rollover to an inherited IRA.
2) Not adhering to the IRA "one-rollover-per-year” rule:
You are permitted to complete only one indirect rollover within any one year period, regardless of how many IRAs you own. This does not mean a calendar year, but on a 12-month basis. This rule does not apply to direct IRA to IRA rollovers, only indirect rollovers. There is no limit to how many direct rollovers you are allowed to complete. If this rule is not followed, the IRS will treat the additional indirect rollover amounts as taxable income.
3) Rolling over your RMD.
Required Minimum Distributions (RMD) are required when you reach age 70 ½. The first distribution from your IRA for any year an RMD is due is considered to be part of your RMD for that year. If you rollover your RMD into another retirement fund, the IRS will consider this an excess contribution to your account and that amount will be subject to a 6% penalty. This can be corrected with no tax consequences if it is removed by October 15th of the following year.
Another common rollover mistake involves completing a Roth conversion with an RMD. A Roth conversion is the moving of assets from a Traditional IRA to a Roth IRA. Since this is considered to be a rollover, the RMD amount is not eligible to be converted to a Roth IRA. The IRS will consider this an excess contribution and will be subject to a 6% penalty if not removed by October 15th of the following year.
4) Rolling assets as different property.
A rollover from one retirement fund to another must consist of the same property.
Here are some examples of rollovers with different property that are NOT acceptable:
Withdraw stock from an IRA, sell that stock, and roll over the cash.
Receive a distribution of stock of company ‘A’ and roll over an equivalent value in shares of ‘B’ company.
There is one exception to this rule: property distributed from a company plan may be sold and the cash received is permitted to be rolled over.
The Bottom Line
Taking the time to plan your rollover can help protect your retirement savings from taking an expensive hit that could have been avoided. Completing an indirect rollover leaves your retirement assets more vulnerable to taxes and penalties should a mistake happen, so if at all possible, consider completing a direct rollover instead.
To view the allowable rollover transactions, please refer to the IRS rollover chart.
Carol Chaudet
(Last Updated 10/12/2019)