If moving your retirement funds around makes you a little nervous, there’s good reason. With many retirement plans, including IRAs and 401(k)s, if you’re not careful, you could end up paying unexpected penalties and additional tax. Understand a few basic rules and consult with a tax professional so you can move your money without making costly mistakes.
In IRA lingo, moving money from one retirement account to another is known as a rollover, a transfer, or a conversion. And, as you may have guessed, those transactions have rules. Here are a few things to understand about moving your retirement funds.
Know the difference between transfers, rollover, and conversions.
The difference between an IRA transfer and a rollover is that a transfer occurs between retirement accounts of the same type, while a rollover occurs between two different types of retirement accounts.
For example, if you move funds from an IRA at one bank to an IRA at another, that’s a transfer. If you move money from your 401(k) plan to an IRA, that’s a rollover. And a Roth conversion occurs when you change a traditional IRA to a Roth IRA. The distinction is important because the IRS treats these transactions differently for tax purposes.
Roll funds from one retirement plan directly into another.
The last thing you want to do is accidentally pay more taxes than you have to. So take note: money from a retirement plan that is paid directly to you may be subject to mandatory tax withholdings even if you intend to roll it over to another retirement plan later.
Save yourself that step (and that money) by making sure the funds you roll over go directly to another retirement plan or IRA in one of two ways:
- A direct rollover. If you’re getting a distribution (payment) from a retirement plan, you can ask your plan administrator to make the payment directly to another retirement plan or to an IRA. The administrator may issue your distribution in the form of a check made payable to your new account.
- Trustee-to-trustee transfer. If you’re getting a distribution from an IRA, you can ask the financial institution holding your IRA to make the payment directly from your IRA to another IRA or to a retirement plan.
With both rollovers and transfers, the money must be in the new account no later than 60 days from when it was withdrawn from the original retirement account. You technically can “borrow” these funds during that time period, but that’s a little risky because if you don’t deposit the full amount into the new account, you’ll end up paying an early withdrawal penalty and income tax on that amount.
It’s also important to note that you can only roll over or transfer IRA funds once per year.
Switching jobs gives you rollover options.
If you have a retirement plan at your current job and you change jobs, you usually have choices regarding those funds. You may be able to move the money into a 401(k) with your new employer, move it into an IRA, or even split the amount between both the IRA and the 401(k), depending on the terms of your new employer’s plan. Check out the IRS’s rollover chart for a summary of which types of accounts you can roll over funds to and from.
You can roll over after-tax funds to a Roth IRA.
You can usually roll over post-tax funds from a qualified employer plan into a Roth IRA. This is good news because Roth IRAs offer significant tax advantages and other features that make them valuable savings tools.
You fund a Roth IRA with post-tax dollars. Since you pay taxes on the front end, you don’t have to worry about paying taxes on your earnings or qualifying withdrawals.
Learn more about Roth IRAs here.
If you’re ready to roll over your retirement plan, be sure to consult with a tax professional familiar with your situation. Also visit the IRS website for the most current information.