IRS Updates Retirement Rollover Rules: What You Need to Know Before Moving Money Between Plans and IRAs
Moving money from one retirement account to another may seem like a simple financial transaction, but rollover rules can be surprisingly complicated. A mistake can turn a tax-deferred retirement transfer into a taxable distribution and, in some situations, trigger an additional tax.
New IRS guidance is providing greater clarity around how retirement assets can move between employer-sponsored retirement plans and individual retirement accounts, giving savers and plan administrators important information about which transactions are permitted and how they should be handled.
The guidance is especially relevant for workers changing jobs, people consolidating retirement accounts and individuals looking for greater flexibility in managing their long-term savings.
What Is a Retirement Rollover?
A rollover generally occurs when money or other eligible assets are moved from one retirement arrangement into another qualifying retirement account.
For example, a worker who leaves a company may decide to move money from a 401(k) into an IRA. In another situation, someone may want to move eligible IRA assets into an employer retirement plan.
When properly completed, a rollover can allow retirement savings to continue growing without the distribution being immediately treated as taxable income.
The IRS generally allows many retirement distributions to be rolled over, although important exceptions apply.
Why the New Guidance Matters
Retirement accounts operate under different sets of rules, and not every account can accept every type of rollover.
The updated guidance helps clarify the types of retirement assets that can move between different plans and the conditions that must be satisfied for the transaction to receive rollover treatment.
This is particularly important because retirement savers can have several different accounts throughout their careers.
Someone might have an old 401(k), a current employer's retirement plan, a traditional IRA and potentially other retirement accounts.
Understanding which accounts can be combined or transferred can help prevent costly mistakes.
Direct Transfers Can Make the Process Easier
One of the safest ways to move retirement money is generally a direct rollover.
Instead of receiving the retirement distribution personally, the money is transferred directly from the existing plan or financial institution to the receiving retirement account.
This approach can help avoid mandatory federal withholding that can apply when an eligible taxable distribution from an employer retirement plan is paid directly to the participant.
For many people, a direct transfer also reduces the risk of accidentally missing an important deadline.
The receiving institution can coordinate with the existing retirement provider to move the assets without the participant taking possession of the money.
The 60-Day Rollover Rule Still Matters
When a retirement distribution is paid directly to the individual rather than transferred between institutions, the taxpayer generally has 60 days to deposit the eligible amount into another qualifying retirement account.
Missing that deadline can create serious tax consequences.
The amount that should have been rolled over may become taxable, depending on the circumstances, and an additional tax may apply to certain early distributions.
The IRS can provide relief from the 60-day requirement in qualifying situations, but taxpayers should not assume that a missed deadline will automatically be forgiven.
That is one reason direct transfers are often preferable when they are available.
Not Every Distribution Can Be Rolled Over
A common misconception is that every withdrawal from a retirement account can simply be moved into another account.
That is not the case.
Certain distributions are generally excluded from rollover treatment. These can include required minimum distributions, certain hardship distributions, some corrective distributions and other payments that fall outside the eligible rollover rules.
Plan loans treated as deemed distributions can also present special problems.
Before moving retirement money, account holders should determine whether the particular distribution is actually eligible for rollover treatment.
Employer Plans Have Their Own Requirements
A retirement plan generally does not have to accept every type of rollover.
This means that even when federal tax rules permit a particular transaction, the receiving employer plan may have its own rules regarding which rollover contributions it accepts.
Someone considering moving an IRA into a 401(k), for example, should first check with the plan administrator.
The same principle applies when moving assets from one employer plan to another.
Checking the receiving plan before initiating a transfer can prevent money from being sent somewhere that cannot accept it.
Roth Accounts Require Special Attention
Roth retirement accounts operate differently from traditional retirement accounts, which makes Roth rollovers an area where careful planning is especially important.
A designated Roth account in an employer retirement plan generally has specific rollover options, and Roth IRAs have their own rules.
A Roth IRA cannot simply be treated like a traditional IRA when determining where money can be transferred.
Tax treatment can also vary depending on whether the money represents contributions, earnings or another type of retirement distribution.
Anyone moving Roth assets should therefore confirm that the receiving account is eligible to accept them and that the transaction will preserve the intended tax treatment.
The One-Rollover-Per-Year Rule
Another important rule involves IRA-to-IRA rollovers.
Generally, an individual is limited to one IRA-to-IRA rollover during a 12-month period.
The limitation is broader than simply counting each IRA separately. The rule generally applies across an individual's IRAs rather than allowing unlimited rollovers simply because the person owns multiple accounts.
However, important transactions are not subject to this one-rollover-per-year restriction.
For example, direct trustee-to-trustee transfers between IRAs are not treated the same way as a rollover where the individual receives the money.
Plan-to-IRA, IRA-to-plan and plan-to-plan rollovers are also treated differently under the rules.
Understanding this distinction can prevent an investor from unintentionally violating the rollover limitation.
Why Job Changes Often Trigger Rollover Decisions
Changing jobs is one of the most common situations in which people consider moving retirement savings.
When an employee leaves a company, the old 401(k) may remain with the former employer, but the worker may prefer to consolidate accounts.
Possible destinations can include a new employer's retirement plan or an IRA, depending on the individual's circumstances and the rules of the receiving account.
Keeping retirement money in the old plan may sometimes make sense, particularly if the plan offers low-cost investments or valuable features.
Moving the money may make sense in other circumstances.
The important point is that the decision should be based on the individual's financial situation rather than simply assuming that every old 401(k) should be rolled into an IRA.
Taxes Can Become a Major Issue
The primary attraction of a properly executed rollover is that eligible retirement savings can generally remain tax-deferred rather than becoming immediately taxable.
But receiving a retirement distribution personally can create withholding requirements.
For certain taxable distributions from employer-sponsored plans, mandatory federal income tax withholding generally applies when the money is paid to the participant.
This can create a problem if someone intends to roll over the entire distribution.
For example, if part of the distribution is withheld for taxes, the individual may need to replace the withheld amount with other funds in order to roll over the full eligible distribution.
A direct rollover can generally avoid that mandatory withholding.
Early Withdrawals Can Add Another Layer of Cost
Retirement accounts are designed for long-term saving, so withdrawing money before the applicable retirement age can create additional tax consequences.
A taxable amount that is not successfully rolled over may become part of the individual's income.
In some circumstances, an additional 10% tax on early distributions can also apply to people who are below age 59½, unless an exception is available.
That means an incorrectly handled rollover can potentially create two financial problems at once: ordinary income tax and an additional early-distribution tax.
Plan Administrators Also Have Responsibilities
The new guidance is not only relevant to individual retirement savers.
Retirement plan administrators need to determine whether incoming rollover contributions meet applicable requirements.
Plans can establish procedures for reviewing rollover contributions and verifying whether the money is eligible.
This is important because accepting an improper rollover can create compliance issues for the retirement plan.
The IRS has provided information to help administrators evaluate whether rollover contributions meet the applicable requirements.
Consolidating Retirement Accounts Can Have Advantages
For some investors, moving retirement accounts can make financial management easier.
Having several small retirement accounts can make it harder to monitor investments, fees, beneficiaries and overall asset allocation.
Consolidating eligible accounts may provide a clearer view of total retirement savings.
However, consolidation is not automatically the best choice.
Some employer plans may offer investment options, institutional pricing, creditor protections or other features that an IRA does not provide in the same way.
The decision should therefore involve more than simply asking whether a rollover is allowed.
A Rollover Is a Financial Decision, Not Just a Tax Transaction
The tax rules are only one part of the decision.
Investors should also consider investment choices, account fees, withdrawal rules, beneficiary arrangements, creditor protections and the services available through the receiving institution.
A rollover can simplify retirement planning, but it can also create disadvantages if the new account has higher costs or fewer useful features.
For that reason, the most important question is not simply, "Can I roll this money over?"
It is also, "Should I roll this money over?"
What Retirement Savers Should Do Before Moving Money
Before initiating a rollover, it is wise to take several basic steps:
Confirm the type of account the money is coming from.
Determine whether the distribution is eligible for rollover.
Ask the receiving plan whether it accepts the rollover.
Consider using a direct trustee-to-trustee transfer.
Understand whether any withholding will apply.
Check the 60-day deadline if the money is paid directly to you.
Determine whether the transaction involves traditional or Roth assets.
Review investment choices and fees in the new account.
Keep records of the transaction and related tax documents.
Consider speaking with a qualified tax or financial professional when the situation is complicated.
The Bottom Line
Retirement rollovers can provide valuable flexibility for people managing their long-term savings, but the rules are detailed and mistakes can be expensive.
The latest IRS guidance reinforces the importance of understanding which retirement distributions qualify for rollover treatment, which accounts can receive the money and how different types of transfers are treated.
For many savers, a direct transfer between financial institutions can be one of the simplest ways to reduce the risk of unnecessary taxes and missed deadlines.
But every retirement situation is different.
Before moving a large retirement balance, investors should examine the tax consequences, investment options, fees and rules associated with both the existing and receiving accounts.
A properly planned rollover can help keep retirement savings working toward the future. A rushed or incorrectly executed rollover, on the other hand, can turn a routine account transfer into an unexpected tax bill.
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