Mistakes to Avoid During IRA and 401(k) Rollovers

IRA 401k Rollovers

You may have moved on to a new job, but your money is still in a 401(k) or Roth 401(k) with your former employer. Or perhaps you’re about to retire and you’re wondering if leaving your money in a 401(k) is still the best option for you.

If you have a retirement plan from a previous job or an individual retirement account (IRA), there are ways to move funds without getting penalized by the Internal Revenue Service (IRS). These transfers, or rollovers, can be directed through the retirement plan administrator. You can find that information in summary plan description (SPD), provided to you free of charge from the employer who sponsored the plan. If you do not have that information, you may obtain it by contacting the employer’s human resources or the Department of Labor.

You can also complete a 401(k) rollover on your own, or with the help of a financial institution or advisor. You should, however, be careful to avoid any of the following mistakes that can lead to significant tax penalties.

Missing the 60-Day Cutoff

Before you request any funds held in a 401(k), you should have a plan to transfer those funds into a new account. Otherwise, time may slip away, and you could miss this important deadline. Any type of IRA can be a rollover IRA, either a new account or one you already own. For this one deposit, you aren't bound by the usual annual IRA contribution limits, and you can invest the total amount of your previous account.

If distributions from a retirement fund are paid directly to you, the IRS gives you 60 days to deposit the money from one plan or IRA, into a new retirement account.

Note: If you miss the deadline due to circumstances beyond your control, such as administrator errors, emergencies, or other qualified delays, you may be eligible to receive an extension from the IRS.

Should you miss the 60 days and are not eligible for an extension, any pre-tax money in your account now becomes part of your taxable income for that year. If you’re under 59½ years old, you also might pay a 10% early-withdrawal penalty on that money.

Not Waiting 12 Months to Do Another IRA Rollover

The IRS permits one indirect rollover from one IRA to another in a rolling 12-month period, regardless of how many IRAs you own; this is a change from the previous policy of permitting one indirect rollover per IRA in a rolling 12-month period and went into effect on January 1, 2015.

The consequences of doing a second IRA indirect rollover too soon can include paying the early withdrawal penalty (if you’re under 59 ½ years old and do not qualify for an exception) and adding the previously untaxed IRA funds onto your current year’s taxable income, a costly mistake.

It’s important to understand that the once-per-year rule is not actually a calendar year rule. It applies on a rolling 12-month basis. You cannot, therefore, complete one rollover late in one year and another early in the next without penalty.

However, this one-year/12-month rule doesn’t apply in the following cases:

  • A rollover from one employer-sponsored plan, such as a 401(k), to another employer-sponsored plan, which a plan administrator can make on your behalf.
  • A rollover from an employer-sponsored plan to an IRA.
  • A rollover from a traditional IRA to a Roth IRA, which is also called a conversion.
  • A trustee, such as a financial institution, makes a transfer from one IRA to another on your behalf.
  • A trustee transfers money from your IRA to an employer-sponsored plan.

The primary difference between indirect rollovers and all other options is that indirect rollover checks are made payable to the taxpayer, whereas direct rollover checks or transfer requests are made payable to the receiving financial institution on behalf of the taxpayer. For instance, a direct transfer to a Citadel IRA on my behalf would list the payee line as “Citadel Federal Credit Union FBO Robert Elwell,” whereas an indirect rollover check would list the payee line as “Robert Elwell.”

For more detailed information, review the IRS’ chart of acceptable rollovers from various retirement accounts.

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Trying to Roll over Required Minimum Distributions

Once you turn 70½ (or 72 years old, if born after June 30, 1949), you can be compelled to start taking out required minimum distributions, or RMDs, from a traditional IRA, 401(k) or other fund. Your required minimum distribution is the minimum amount you must withdraw from your account each year. While you can withdraw more than the minimum required amount, these withdrawals will be included in your taxable income except for any part that was taxed before (your basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts).

Regardless of the amount withdrawn, you must make sure to avoid rolling any of these funds over into another IRA as this wouldn’t be an approved transfer. However, once you take out the RMD for a year, you may be able to roll over that money into another account without penalty. The sole exception to this is Roth IRAs, which don’t have a RMD requirement until the owner’s death.

It’s not worth avoiding the RMDs either, as you may have to pay a 50% excise tax on the amount not distributed as required, if you do not take any distributions, or if the distributions are not large enough.

Mishandling Inherited IRA Required Minimum Distributions – Post Secure Act

Having knowledge of the existing RMD requirements can be helpful in managing and monitoring your inherited retirement assets, and avoiding costly IRA rollover mistakes.

If you’ve inherited an IRA after January 1, 2020, there are a few changes to the distribution rules.

  • The Stretch IRA has been eliminated unless you are an Eligible Designated Beneficiary, defined as “a surviving spouse, a disabled individual, a chronically ill individual, a minor child, or an individual who is not more than 10 years younger than the account owner." Note: Certain trusts created for the exclusive benefit of disabled or chronically ill beneficiaries are included. These individuals can take distributions over their own life expectancy; an exception applies for minor beneficiaries, who must convert to a 10-year distribution period when they reach 18 years of age.
  • Designated beneficiaries, who are otherwise not eligible for the treatment as previously described, must deplete the account by the 10th calendar year following the year of the IRA owner’s death. If the owner of the IRA was past their Required Beginning Date (RBD), an RMD may also be necessary in years 1-9.
  • Non-designated beneficiaries have a 5-year period to distribute the entire account.
  • There may be different requirements, depending on the plan documents, for employer-sponsored plans. It is generally advised to refer to the plan document to consider your specific options.

Not Transferring the Same Distribution to a New Account During Rollovers

The IRS’ same property rule mandates that the retirement money you receive from a 401(k) administrator or IRA holder is the same money you roll over to a new account. If you repurpose any of it for another use, for example, using a cash distribution to buy stock, then transferring that stock to another retirement account, you'd violate the same-property rule. In this case, the money will be treated as a normal withdrawal, on which you'll have to pay taxes and you could owe a 10% early withdrawal penalty as well.

Some funds can also be withheld for taxes by a plan administrator or account manager before distributing the money to you. This withholding acts as a kind of insurance policy for the IRS, in case an IRA or 401(k) participant spends all of a distribution and doesn’t pay taxes on the money. The amount withheld is 10% of distributions from IRAs and 20% from retirement plans, according to current IRS rules. So as you execute the rollover, it’s up to you to make up that 10% or 20% from other sources to avoid tax penalties.

For example, if your “eligible rollover distribution” is $10,000 and an employer withholds $2,000 for taxes, it’s up to you to make up that $2,000 when you roll over to a new account. If you don’t, you’ll pay taxes on that $2,000 and an early-withdrawal penalty, if applicable. You’d still report the $2,000 as taxes paid in either case and may be refunded if you end up owing less on that distribution.

Moving Funds by Withdrawing Instead of Transferring

If you are simply moving your IRA from one financial institution to another without using the funds, a transfer may be a better option. Consider a trustee-to-trustee or direct transfer. A transfer removes the withdrawal process of the rollover, ensuring the assets go directly to another IRA account and eliminating the risk with the 60-day rule. A transfer is non-reportable and can be done an unlimited number of times during any period.

Not Seeking Guidance When You Have Questions

As you make plans to roll over retirement funds to other accounts, making sure you stay within the IRS guidelines is particularly important. You don’t want to make mistakes that will incur extra costs from early withdrawals and penalties on money that you’ve spent years building up for retirement.

Managing IRAs and other retirement accounts on your own is possible, but it’s complicated and time consuming. A good place to start is with the Financial Industry Regulatory Authority. FINRA is a government-authorized not-for-profit organization that oversees U.S. broker-dealers and provides a wide range of educational financial information, including information on 401(k) rollovers.

The rules and regulations that govern these accounts and how funds may be disbursed and used, however, are extremely detailed. They can be challenging to navigate without making a mistake. Comprehensive, reliable advice can make this process easier and help you feel more confident.

a personal connection and face-to-face conversations are important to you, you can schedule an appointment with one of our knowledgeable financial advisors at Citadel. We’re happy to answer your questions and provide up-to-date information on complex tax and retirement regulations, both at the federal level with the IRS, and at the Pennsylvania state level. Consulting with an expert may help you avoid costly mistakes that could impact your retirement.

For assistance with your particular situation, consult with a member of our investment team.

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