Rollovers From Employer-Sponsored Retirement Plans

A rollover is generally a transfer of assets from a retirement plan maintained by your former employer. Rollovers from an employer-sponsored retirement plan can take one of four forms:

1. A transfer from your old retirement plan directly to an IRA trustee (this is a type of direct rollover)
2. A transfer from your old retirement plan to you, and then, within 60 days, from you to an IRA trustee (this is a type of indirect rollover)
3. A transfer from your old retirement plan directly to the trustee of the retirement plan at a new employer (this is a type of direct rollover)
4. A transfer from your old retirement plan to you, and then from you to the trustee of a retirement plan at a new employer (this is a type of indirect rollover)

Generally, rollovers come from defined contribution plans. A defined contribution plan is a retirement plan in which contributions are based on a set formula (e.g., a percentage of the employee's pretax compensation), while the payout is based on total contributions and investment performance. The 401(k) plan is the most common type of defined contribution plan.

If a rollover is done properly and rules are followed, there will be no taxes or penalties imposed on the retirement plan distribution. In addition, a rollover encourages retirement savings by allowing you to continue tax-deferred growth of the funds in the IRA or new plan. When you are eligible for a rollover from your plan, the plan administrator must send you a timely notice explaining your options, the rollover rules, and related tax issues.

Advantages of Doing a Rollover

A rollover is not a taxable distribution

A properly completed rollover (direct or indirect) is a tax-free transfer of assets, not a taxable distribution. That means that if you complete the rollover within 60 days of receiving the distribution and follow other federal rollover rules, you will not be subject to income tax or early withdrawal penalties on the money. You will not have to pay federal or state income tax on the money until you begin taking taxable distributions from the IRA or new plan. By that time, you may be retired and in a lower income tax bracket. Also, if you are 59 1/2 or older when you take distributions, you will not have to worry about premature distribution penalties.

A rollover allows continued tax-deferred growth

When you do a rollover, you are simply moving your retirement money from one tax-favored savings vehicle to another. This allows the money to continue growing tax deferred in the IRA or new plan, with little or no interruption. Tax-deferred growth allows your retirement money to potentially grow more rapidly than it might outside an IRA or retirement plan. To understand why, consider the power of compounding. As your IRA or plan investments earn money, those earnings compound on top of your principal and any earnings that have already accrued. As this is happening, no tax is due while the funds remain in the IRA or plan. Depending on investment performance, the long-term effect on your savings can be dramatic. In most cases, this benefit is lost if you receive a distribution from your employer's plan and do not roll it over.

A rollover may be an option every time you leave a job

You may be able to roll over your vested benefits in former employer's retirement plan every time you leave a job (whether voluntarily or involuntarily). You generally have the option of rolling over benefits from the old plan to the new plan. There is no limit on the number of rollovers from an employer-sponsored retirement plan you can do, which is an advantage for those who change jobs frequently.

Disadvantages of doing a rollover

You cannot revoke a rollover election

Once you have elected in writing to roll over your retirement plan benefits to an IRA or another plan and received payment, you typically cannot change your mind and revoke the election. If you do try to revoke it, you will generally be subject to income tax and penalties on all or part of the distribution. Before you elect the rollover option, be absolutely certain that this is what you want.

You cannot roll over certain amounts

You generally may not roll over any distribution that is not includible in your taxable income (direct rollovers of after-tax contributions from one qualified plan to another qualified plan and to a traditional IRA are permitted in some cases). Also, you cannot roll over amounts to be taken as required minimum distributions or as substantially equal payments.

An indirect rollover can be costly

If you are considering an  indirect rollover, bear in mind the 20 percent mandatory withholding requirement. To complete the rollover, you must make up the 20 percent out of your own funds, or be subject to income tax and possibly penalties on the shortfall. This can be a problem if you do not have cash available to replace the 20 percent. Also, with an indirect rollover, you generally have only 60 days to complete the rollover. The 60-day period begins with the date on which you receive the distribution from the former employer's retirement plan. If you fail to complete the rollover within this time frame, all or part of the distribution to you will be taxable and perhaps penalized.

Loss of lump sum averaging and capital gain treatment

If you roll over all or part of a distribution from a qualified employer retirement plan into an IRA, neither that distribution, nor any future lump-sum distribution you receive from the qualified plan will be eligible for special 10-year averaging or capital gains treatment.

This information is just a basic overview on rollovers from employer-sponsored retirement plans. For more detailed information or questions, use the contact me link at our website.$

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