An Overview of the Rollover IRA
Last Updated on 16th June 2022 by Jeffrey Camerda
It’s possible to transfer money from 401(k)s and other employer-sponsored retirement plans into an IRA via a rollover IRA. When done appropriately, an IRA rollover retains the money’s tax-deferred status and does not impose taxes or penalties on early withdrawals.
If you’re looking for cheap fees and a broad variety of investments, a rollover Individual Retirement Account (IRA) may be a better alternative than your company’s 401(k).
Old 401(k) plan options
It’s common for people to have three options when they’re ready to leave a job.
- Ignore it and go on. As long as you get permission from your ex-employer, you may keep your money in the bank account. As an ex-employee, you may be charged higher 401(k) costs since you will no longer have access to an HR staff to assist you with issues.
- Make it part of a long-term financial strategy. Many people’s best option is to transfer their funds to an IRA or the retirement plan of their new employment.
- Cash in. This is, by far, the worst choice you have. To add insult to injury, cashing out comes with hefty fines and taxes from the Internal Revenue Service. A 10% early withdrawal charge and regular income taxes will be applied to the amount withdrawn. As a result, you may be required to fork up as much as 40% of your earnings up front.
Learn more about IRA rollovers to discover whether they’re good for you.
How to move 401(k) funds to an IRA
An IRA rollover involves three stages.
- Decide on an IRA rollover account.
- Decide on an IRA rollover company
- Transfer the funds
Taxes For IRA rollovers: two guidelines to keep in mind
You’re fine to go if you conduct a straight rollover. Retirement income is exempt from taxes until you begin withdrawing funds.
If you get a check made out to you as part of an indirect rollover, be aware of these regulations to avoid a large tax bill:
The 60-day period
You have 60 days from the day you receive the distribution to transfer the money to an IRA through an indirect rollover. Because of this, if you fail to meet that deadline, you may be subject to a 10% early withdrawal penalty from the IRS, which would add to your income tax bill.
Taxes are deducted.
Your 401(k) balance will be deducted by 20% when you do an indirect rollover from your employer’s retirement plan. The plan administrator deducts 20% from your dividend to pay taxes. Taxes will need to be paid on a Roth IRA if you’re moving money out of a standard 401(k) and into a Roth IRA.
If you want to receive your money back, you must deposit the whole amount of your IRA, including any taxes deducted.
Your previous company may issue a check for $16,000, which is 20% of your entire 401(k) account balance (i.e., $20,000 x 20%). If you don’t want to use a Roth IRA, you’ll have to save $4,000 in order to contribute the whole $20,000 to your IRA.
When tax season rolls along, the Internal Revenue Service will discover that you’ve transferred your whole retirement account and provide a refund for the money that was withheld.
In addition, you’ll avoid paying a 10% fine. However, if you only contributed $16,000 to the IRA, the IRS will see this as an early withdrawal of $4,000 from the account. On top of the early withdrawal penalty, you’d owe income tax on the $4,000 you took out.
Can you contribute to a rollover IRA?
Yes. Contributions will be capped in 2020 at $6,000 ($7,000 for those 50 and older). In the case of a Roth IRA rollover, your capacity to contribute may be much more limited because of your income.
If you or your spouse has access to a company retirement plan and your income exceeds a specific level, you may be unable to deduct conventional IRA contributions from your yearly taxes.
To transfer your rollover assets back to a 401(k) from an IRA, you’ll need to separate your IRA contributions and rollover monies into two separate accounts.