Individual Retirement Rollover Accounts
Rollover Accounts (IRA Rollovers)
There are several types of IRA transfers that are commonly called rollovers.
1. Rolling over an IRA into a different
IRA investment at the same institution or at a different
With the first type of rollover, you are moving your IRA assets from is where you close an IRA brokerage account, get a check for
the balance and deposit that amount to open a different mutual fund IRA. Another example is where you take your IRA money out of an IRA savings account and use the funds to purchase
a certificate of deposit at the same institution for your IRA. As long as you put all the money from the old IRA investment into the new one within 60 days, your IRA is intact (see
General rollover rules regarding a risk with this approach where you directly handle IRA assets). Another way of handling rollovers is to fill out forms so that you don't touch the
IRA assets at all. Instead, the institutions handle the transfer.
2. Moving your money from a qualified plan (e.g.,
401(k) plan) into a traditional IRA
3. Converting your traditional IRA to a Roth
4. Rolling over a retirement distribution as
a surviving spouse
5. Rolling over a distribution received under
a divorce or support proceeding
Opening a Rollover IRA
When you take a lump sum payment from a qualified retirement plan and use it to establish an IRA account, that's called opening a rollover IRA. There's a 60-day period here, too,
for transferring your qualified plan assets (see General rollover rules).
Starting in 1998, the Roth IRA came into effect. If you qualify, you may convert a traditional IRA to a Roth IRA (see Conversion to a Roth IRA).
A surviving spouse as the beneficiary of a deceased spouse's qualified plan account may convert that account into an IRA.
A court order may allow a spouse to receive part or all of the retirement benefits of a spouse or former spouse. Those benefits may be rolled over into an IRA.
General IRA Rollover Rules
1. The first rule to follow is the 60-day rule. If you do
any type of rollover, you have to deposit the full amount within 60 days of
the distribution. If you miss this deadline, then the funds are treated as
having been distributed to you and become part of your taxable income.
Converting to a Roth IRA
You'll probably want to avoid personally handling the assets before they are
put into another IRA. Here's why. With direct distributions to you, the payout
check will be only 80% of the total amount from the qualified plan. The other
20% is required to be withheld as tax when distributions are made directly
to you. That means if you're going to deposit the full amount into the rollover
IRA, you'll have to tap another source-like your savings-to come up with the
20% that's been withheld. If you deposit the full amount within the 60 day
period, you'll get the 20% back after you file your income tax return for that
year. However, your wait for the return of your money could be a year or more.
It could get worse. If you can't come up with enough money to cover the 20%
that was withheld, that 20% is considered to be a distribution to you (even
though you never received or touched it). Distributions are taxable income
to you and, if you're not yet age 59½ (or are disabled, separated from service
after age 55 or have deductible medical expenses exceeding 7.5% of your adjusted
gross income), you'll have to pay a 10% early distribution penalty, too.
The good news is that there is an easy way to avoid this withholding and
Instead of a direct payout to you, have the retirement money transferred directly
to the institution handling your rollover IRA. If you don't handle the money,
then the 20% withholding is avoided and the full amount goes into the rollover
IRA. But, if you need access to the cash during the 60 day period, this approach
won't help you out.
2. Keep rollover IRAs separate for future flexibility In the future,
you may want to transfer your rollover IRA from your old employer's plan into
a new employer's plan. To be eligible to do so, you need to keep rollover IRA
money separate from other IRAs you may have. If you don't keep the money separate,
you won't be eligible to move it to your new employer's plan. To be in a position
to possibly make this move down the line, set up a rollover IRA-known as a
conduit IRA-to hold your rolled over money and do not commingle it with any
other IRA funds. One reason to keep your options open is that although you
can't borrow from an IRA, you may be able to do so from your new company's
3.Don't mix pre-taxed and already taxed qualified plan money Except
for a conversion to a Roth IRA, the only contributions to a qualified retirement
plan that can be moved into a rollover IRA are those that weren't already taxed.
If you've made after-tax contributions or if your employer has made supplemental
contributions that aren't tax deductible, that money needs to be invested separately.
This rule can be a blessing because it will simplify separating out taxable
and non-taxable distributions in the future.
4. Keep rollover IRAs separate for future flexibility If you receive
a lump sum pension payout, you can put all or part of it in a rollover IRA.
Also, if the payout is made in a series of substantially equal payments over
a period of not more than 10 years, you can usually put some or all of those
payments in a rollover IRA, too.
Virtually all qualified retirement accounts and plans may be converted to a Roth
IRA (pending legislation may allow the one exception, 457 plans, to also be rolled
over to an IRA). In some cases (e.g., a traditional IRA), the onversion to a
Roth IRA may be done in one step. In other cases, it's a two-step process where
you first roll over your retirement plan assets into a traditional IRA, and then
you convert the traditional IRA into Roth IRA.
Eligibility for Converting to a Roth IRA
Whether you qualify to do a conversion to a Roth IRA depends upon your modified
adjusted gross income ("MAGI") and your marital status. If your MAGI is no more
than $100,000, you may qualify to convert to a Roth IRA. What is your MAGI? It's
the number on the last line of page 1 of your federal income tax return, Form
1040 (your adjusted gross income), which may be modified for certain items.
It is important to note that you do not include the amounts you are converting
to determine whether you are above the $100,000 MAGI limit.
The $100,000 limit applies if you're single or you're married. However, there
are special rules for married couples converting to a Roth IRA. A married person
who has lived apart from his or her spouse for the entire taxable year can treat
himself or herself as unmarried for conversion purposes, and file a separate
income tax return (subject to the $100,000 limit on his or her separate MAGI).
In all other cases, a married person filing a separate return is not permitted
to convert an amount to a Roth IRA, regardless of the person's MAGI.
There are special rules on recharacterizing (converting back) a Roth IRA to a
traditional IRA. You may need to do this, for example, if your income turns out
to be too high to be eligible for a conversion.
Benefits for Converting to a Roth IRA
The primary motivation for converting to a Roth IRA is to ensure that future
earnings on the account are income tax free.
Benefits for Converting to a Roth IRA
If you convert to a Roth IRA, you may need to pay some additional income tax
now on the converted amount. It depends upon the amount converted and your other
income and deductions.
When you do a conversion, the amounts transferred to the Roth IRA are considered
as income to you in that year, so you need to be prepared to possibly pay income
tax (but no penalty) on the converted amount. The converted amount is added to
your income in the year of conversion. If you need to use IRA funds (as compared
to funds held in your personal name) to pay the income tax due on the conversion,
you may also pay a 10% penalty on the funds used to pay the income tax. Payment
of income tax from IRA funds will also reduce the amount you have growing in
the potentially income tax free Roth IRA. Note that prior non-deductible IRA
contributions are not considered as income to you on the conversion.
Besides having more income to pay tax on, converting may lead to some unexpected
tax consequences. If you convert to a Roth IRA, you may be in a higher income
tax bracket by including the converted amount in your income. As a result, your
income level may be high enough so that the extra income from the conversion
will reduce your allowable amount of personal exemptions, itemized deductions,
and rental losses and possibly cause otherwise non-taxable Social Security benefits
you are receiving to become taxable. Also, you may need to increase your estimated
tax payments due to the conversion increasing your income. Finally, since the
converted amount is added to your income, this may limit or eliminate your eligibility
under the income limits to make a regular contribution to a Roth IRA that year.
Converting to a Traditional IRA to a Roth IRA
The main reason to convert to a Roth IRA is to have an income tax-free retirement
You need to determine whether paying income tax now is worth making the change
to a Roth IRA that can be income tax-free at the time of distributions. Keep
in mind that if you do not convert to a Roth IRA, distributions in the future
can be subject to ordinary income tax (the federal rate is from 15% to 39.6%,
as of January 1, 2001 ).
Reasons for Converting to a Roth IRA
1. You expect your anticipated income tax bracket to be higher
at the time that you take distributions
Reasons for Not Converting to a Roth IRA
2. You expect larger growth and earnings from your IRA until distributions
3. You want the option to allow continued tax free growth by avoiding
starting distributions at age 70½ or any age--you do not have to take distributions
from your Roth IRA
4. The ability to leave income-tax free money to beneficiaries
1. You expect your anticipated income tax bracket to be lower
at the time that you take distributions
Other Roth IRA Rules
2. You expect lower growth and earnings from your IRA until distributions
3. You may possibly pay income tax now at the time of conversion on
the converted amount (depending upon your income and deductions)
4. Other potential income tax consequences of converting (e.g., the
effect on itemized deductions)
5. You don't have non-IRA funds to pay income tax due on the conversion
6. Possibly, protection against creditors with a traditional IRA and
Roth IRA may not apply in your state
The general rule is that for you to receive distributions free of income tax
and penalties, your Roth IRA needs to be open at least five years and you need
to be at least age 59½ when you take distributions.
Retirement Planning Considerations
Part of your IRA tax planning is looking ahead to the interests of your beneficiaries.
You may want to get legal and tax advice on how to complete your beneficiary
designations and coordinate them with your estate plan. Properly completed designations
can allow better income tax opportunities, help save estate (death) tax, avoid
probate, and avoid creditor claims on retirement assets.
Income Tax Benefits
You can extend the life of a tax-deferred IRA for five years and sometimes more
by leaving it to a living beneficiary rather than to your estate. That's because
IRA distributions are based on life expectancies and an estate doesn't have one.
If you name your estate as the beneficiary, that can speed up when income tax
is due on your IRA.
Extra care also needs to be taken in naming trusts as a beneficiary of most retirement
assets in case of a death. Sometimes, naming trusts as a beneficiary can trigger
income tax sooner than it would otherwise be owed and reduce the amount ultimately
shielded from death tax.
Estate Tax Benefits Retirement assets are added to your other assets and
may be subject to federal and/or state death (estate) tax. Consult with your
advisor about ways to defer or avoid estate tax.
Avoiding Probate Properly completed beneficiary designations can avoid
probate upon a death. Avoiding probate can reduce attorneys' fees, executor fees
and court costs and minimize delays.
Avoiding Creditor Claims
IRAs that avoid the probate court may have special creditor protection. That
protection may be lost if your estate is named as the beneficiary. Consult with
your attorney for guidance on the creditor protection issue.
For more information:
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Charles M. Bloom, Registered Principal offers securities
and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.
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