Rollover IRA | Everything Explained

Updated: Jun 13



Overview:

A rollover account allows you to move funds from your old employer-sponsored retirement plan into an IRA. With a rollover account you can preserve the tax-deferred status of your retirement assets, without paying current taxes or early withdrawal penalties at the time of transfer.

Rollover IRAs are used to accept rollovers from QRPs (Qualified retirement plans such as a 401(k), profit sharing plans, pensions etc.)

  • Rollovers can accept pre-tax funds.

  • If post tax funds, those should be rolled into a Roth IRA as a separate movement from the QRP.

Other qualified retirement plans you can put in rollover IRAs include but are not limited too:

  • 403(b)

  • 457 plan

  • SEP IRA

4 options you have prior to rolling funds from a previous employers plan

1. Leave the plan with your former employer if permitted

2. Roll the assets to a new employers plan if permitted

3. Roll the assets to an IRA account

4. Cash out the account value (taxes will be applied)

Contribution:

Clients can contribute as long as they have earned income in the year they are contributing. Follow the same limits as the normal IRAs. (link to contribution limits here)

Distribution:

If a rollover had pre tax and after tax portions individuals will have to file form 8606 when doing taxes (8606 is not required when rolling funds into an IRA).

IRA may be subject to tax/premature distribution penalty.

  • Age 59½ and under: Taxes and 10% penalty applies.

  • Age 59½ to 72: Taxes apply, but there is no 10% early withdrawal penalty.

  • Age 72 & over: Taxes apply. Distributions are required by law (RMD).

Rollover Process:

  1. Individuals must call their plan administrators of their previous plan to initiate rollovers. They will usually either need the person to fill out rollover form OR require your brokerage to mail or fax a letter of acceptance. (You'll have to open a rollover IRA before submitting paperwork for transfer, usually only 10-15 minutes online is all that is needed).

  2. Rollovers can take up to 2-4 weeks. (Be sure to ask your brokerage for processing times as they can be days behind at times).

  3. Once completed make sure the brokerage codes it as a rollover and not transfer, distribution or etc.

Checks from QRP should be made out in the form of:

  • Company/Brokerage name FBO (your name) IRA or Rollover IRA

  • Account # can be anywhere on the check (payable or memo line)

Mailed to:

Corresponding address for your brokerage account

Note: If your QRP issued the check directly in your name, they are required by the IRS to withhold a mandatory 20% for federal taxes.

For example: Richard Allen has $100,000 in his account at Old 401(K) and wants to rollover to his IRA but did not tell Old 401(K) that he wants it designated as a rollover to his IRA. They send a check for $80,000 and $20,000 goes to the IRS. Richard can now either:

  • Put the $80,000 in his IRA within 60 days or

  • Put the $80,000 and write another check for $20,000 within 60 days

If you cover the 20% with your own funds that 20% withheld is credited toward your income tax liability when you file your tax return. If you choose not to cover that 20% the IRS will consider that 20% withheld as a distribution, making it subject to taxes and a possible 10% early withdrawal penalty if under age 59½.

Rollover versus Transfer:

Transfer - a non reportable movement of retirement assets between like accounts. A transfer is not reported to the IRS. Example IRA > IRA

Rollover - a reportable movement of retirement assets from 1 account type to another account type. It is considered reportable because the delivering firm will report the disbursement of funds on IRS form 1099-R and the receiving firm will report the receipt of the rollover on IRS form 5498. While direct rollovers between firms would not be taxable event, the activity is reported to the IRS. Example 401(k) to IRA