Individual Retirement Account (IRA) Rollover

Definition

An Individual Retirement Account (IRA) Rollover is a provision under the IRA law that permits individuals who receive lump-sum payments from their company’s pension or profit-sharing plans—triggered by retirement or termination of employment—to transfer the funds tax-free into an IRA investment plan within 60 days. This rollover allows the individual to defer taxes on the lump-sum payment and avoid immediate tax liabilities.

Examples

Direct Rollover: John retires and receives a lump-sum payment from his employer’s pension plan. He arranges for the payment to be transferred directly into his IRA. Because this is a direct rollover, the distribution is not subject to tax withholding, and John avoids immediate taxation and penalties.
Indirect Rollover: Sarah is leaving her job and receives a $100,000 lump-sum payment from her profit-sharing plan. She receives a check and decides to deposit it into her IRA within 60 days. The plan administrator withholds 20% ($20,000) for taxes, so Sarah receives $80,000. To roll over the full amount tax-free, Sarah must deposit $100,000 into her IRA by using additional funds to cover the $20,000 withheld. If she only deposits the $80,000, the remaining $20,000 is treated as a taxable distribution and may incur penalties.

Frequently Asked Questions (FAQs)

What is an IRA rollover?

An IRA rollover allows individuals to transfer eligible retirement plan funds from one account into an IRA without incurring tax penalties, provided the transfer occurs within 60 days.

Who is eligible for an IRA rollover?

Individuals who receive a lump-sum distribution from their employer’s retirement plan due to retirement or termination of employment are eligible for an IRA rollover.

What happens if the rollover is not completed within 60 days?

If the rollover is not completed within 60 days, the distribution is subject to income tax and possible early withdrawal penalties.

What is a direct rollover?

A direct rollover involves transferring funds directly from one retirement account to another, avoiding the 20% mandatory withholding tax.

What is an indirect rollover?

An indirect rollover occurs when the account holder receives the distribution and deposits it into another retirement account within 60 days. The payor must withhold 20% of the distribution amount for taxes.

Is there a limit on how many IRA rollovers I can do in a year?

Yes, under IRS rules, you can perform only one IRA-to-IRA rollover per 12-month period.

Can I roll over funds from a Roth IRA?

Yes, funds from a Roth IRA can be rolled over to another Roth IRA. Traditional IRA funds can be rolled over to another traditional IRA or Roth IRA, but the latter may trigger taxes.

Direct Rollover: A transfer of assets from a qualified retirement plan directly to an IRA, thus avoiding withholding taxes.
Indirect Rollover: A transfer of assets where the recipient handles the transfer and must complete it within 60 days to avoid taxes and penalties.
Mandatory Withholding: The automatic withholding of 20% of a distribution for tax purposes when the funds are not directly rolled over to another retirement account.
Qualified Retirement Plan: Employer-sponsored retirement plans like 401(k), 403(b), and profit-sharing plans.

Online References

Suggested Books for Further Study

“The Bogleheads’ Guide to Retirement Planning” by Taylor Larimore, Mel Lindauer, Richard A. Ferri, and Laura F. Dogu
“IRA Wealth: Revolutionary IRA Strategies for Real Estate Investment” by Patrick W. Rice
“Retirement Planning Made Simple: The 401k Manual” by Marvin Trojan

Fundamentals of Individual Retirement Account (IRA) Rollover: Finance Basics Quiz

### What is the primary benefit of performing an IRA rollover? - [ ] Receiving cash immediately - [x] Deferring taxes on the lump-sum distribution - [ ] Avoiding contributions to retirement plans - [ ] None of the above > **Explanation:** The primary benefit of an IRA rollover is to defer taxes on the lump-sum distribution by transferring it into another qualified retirement account within 60 days, thereby avoiding immediate tax liabilities. ### What percentage must be withheld if the IRA funds are not transferred directly to an eligible plan? - [x] 20% - [ ] 10% - [ ] 25% - [ ] 30% > **Explanation:** If the IRA funds are not transferred directly to an eligible plan, the payor must withhold 20% of the distribution for tax purposes. ### What is the time frame within which an individual must complete an IRA rollover to avoid tax and penalty? - [ ] 30 days - [x] 60 days - [ ] 90 days - [ ] 120 days > **Explanation:** The rollover must be completed within 60 days to avoid paying income taxes and penalties on the distribution amount. ### What happens if only 80% of the distribution is transferred to a new IRA, with 20% withheld? - [ ] No penalties will occur. - [ ] The remaining 20% will be refunded. - [x] The participant will pay income tax and a penalty tax on the 20% withheld. - [ ] The full amount can still be considered a rollover. > **Explanation:** If only 80% of the distribution is transferred, the remaining 20% withheld will be subject to income tax and potentially penalty taxes. ### Can an indirect rollover result in immediate tax withholding? - [x] Yes - [ ] No - [ ] Only if requested - [ ] Never > **Explanation:** Yes, in an indirect rollover, the payor must withhold 20% of the distribution for tax purposes. ### How often can you perform an IRA-to-IRA rollover? - [ ] Unlimited times within a year - [ ] Once per year - [x] Once per 12-month period - [ ] Twice per year > **Explanation:** IRA-to-IRA rollovers can only be performed once per 12-month period according to IRS rules. ### What are the tax implications of rolling over a traditional IRA to a Roth IRA? - [x] Taxes will be due on the rolled-over amount - [ ] No taxes will be due - [ ] Penalty taxes apply only - [ ] State taxes but not federal taxes will apply > **Explanation:** When rolling over from a traditional IRA to a Roth IRA, the amount rolled over will be subject to income tax in the year of the rollover. ### What type of retirement accounts can receive an IRA rollover? - [ ] Only other IRAs - [ ] Only 401(k) plans - [ ] Only Roth IRAs - [x] IRAs, 401(k) plans, 403(b) plans, and other qualified retirement plans > **Explanation:** IRA rollovers can be made into IRAs and other qualified retirement plans, including 401(k) and 403(b) accounts. ### What is the purpose of the IRS's 60-day rollover rule? - [x] To ensure timely reinvestment of retirement funds - [ ] To generate tax revenue quickly - [ ] To limit the number of rollovers - [ ] To benefit plan administrators > **Explanation:** The 60-day rollover rule ensures that retirement funds are reinvested timely into another qualified retirement plan to continue deferring taxes. ### What penalty is involved with early withdrawal if an IRA rollover is not completed correctly? - [ ] 5% penalty - [x] 10% penalty - [ ] 20% penalty - [ ] 30% penalty > **Explanation:** If an IRA rollover is not completed correctly and there is an early withdrawal for those under the age of 59½, a 10% early withdrawal penalty is generally applied.

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