Say you’re leaving your job. There are numerous things you must attend to before you clock out for the last time: clean out your desk, train your replacement, have an exit interview, attend your going-away pizza party.
One task that may not be top of mind, but is important, is figuring out what to do with the retirement account you have set up through the company you’re leaving. Once you separate from your employer you will have a few options to choose from when deciding what to do with your retirement savings and we want to make sure you’re well informed to make the best decision.
If you’re simply moving from a company with a 401(k) to another company with a 401(k), you may choose to complete a 401(k) rollover from the old account to your new one.
What if your new company doesn’t offer the same type of retirement account as your old one? Perhaps you’ve had a 401(k) for the past 10 years, but your new company provides a SEP IRA or SIMPLE IRA. How do you move your assets from your old retirement account to this new IRA?
Maybe your new employer doesn’t have a retirement account option at all. Or you could be leaving one job before having another one lined up. In these cases, you may want to open your ira investment account.
What’s an IRA Rollover?
An IRA rollover is the movement of funds from a qualified plan, like a 401(k) or 403(b), to an IRA. This scenario could come up when changing jobs or when switching accounts for reasons such as wanting lower fees and more investment options.
The concept of an IRA rollover is simple enough, but there are several factors that people should be aware of regarding what an IRA rollover is and how it works.
People generally roll their funds over so that their retirement money doesn’t lose its tax-deferred status. But, let’s say you leave your job and want to withdraw the money from your 401(k) so you can use it to pay some bills. In this case, you’d be taxed on the money and possibly receive a penalty for withdrawing funds before age 59 ½.
However, if you roll your money over instead of withdrawing it, you don’t have to pay taxes or fees for an early withdrawal. Plus, you can keep saving for retirement and accruing compound interest on that money.
When you roll funds over to a new IRA, you should follow several IRA rollover rules that can help ensure you do everything legally, don’t have to pay taxes, and don’t pay fines for any mistakes.
8 IRA Rollover Rules to Know
Rule 1: Decide What Type of Rollover You Want
You can choose between two types of rollovers and it’s crucial to know the differences between each.
First, you may choose a direct rollover, which is the moving of funds directly from a qualified retirement plan to your IRA, without your ever touching the money. Your original company may move these funds electronically or by sending a check to your IRA provider. With a direct rollover you don’t have to pay taxes or early distribution penalties since your funds move directly from one tax-sheltered account to another.
The second option is an indirect rollover. In this case, you withdraw money from your original retirement account by requesting a check made out to your name, then deposit it into your new IRA later.
Some people choose an indirect rollover because they need the money to accomplish short-term plans, or they haven’t decided what they want to do with the money upon leaving their job. Other times, it’s because they simply don’t know their options.
Many people prefer a direct rollover to an indirect rollover, because the process is simpler. With a direct rollover, you aren’t taxed on the money. With an indirect rollover, you are taxed, and if you’re under 59 ½ years old, you have to pay a 10% withdrawal fee, unless you follow specific IRA rollover rules. You should consult with a tax professional to understand the implications of an indirect rollover prior to making this election.
Keep in mind that a transfer is different from a rollover: A transfer is the movement of money between the same types of accounts, while a rollover is the movement of money from a qualified plan into a new plan or individual retirement account one type of retirement account to a different kind of retirement account, as would be the case when moving funds from a 403(b) to a traditional IRA.
Rule 2: Complete an Indirect Rollover Within 60 Days
If you do choose an indirect IRA rollover, your employer must withhold rollover 10–20% in taxes. If you later decide to deposit the funds into an IRA within the 60 day window, IRS rules require you to make up the taxes withheld with outside funds. Otherwise, you will be taxed on the withholding as income.
If you deposit the full amount…the amount you received plus the withheld taxes, you will report a tax credit of the withheld amount. The withholding will not be returned to you, but rather settled up when you file that years taxes.Keep in mind that this is a 60-day rule, not a two-month rule, so be sure to do the math correctly.
Rule 3: Don’t Forget the Same-Property Rule
When you withdraw assets from your retirement account for an indirect rollover, it’s beneficial to deposit those exact same assets into your IRA.
For example, if you take out $10,000, then $10,000 must go into your IRA, even if some of the original withdrawal was withheld for taxes. If you withdraw stocks, those same stocks must go into the new IRA, even if their value has changed.
This means that when you withdraw money, you can’t use the cash to invest, then put the money you earn from those investments into the IRA. That money would be considered regular income, so you’d be taxed on it.
If you break this rule, not only will you have to pay taxes, but you may also be required to pay a penalty.
Rule 4: You Can Only Do a Rollover Once per Year
If you’re rolling funds over from an IRA, you can only complete a rollover once every 12 months . There are many exceptions, such as trustee-to-trustee transfers, rollovers from a 401(k) plan to an IRA—and vice versa—and rollovers from a traditional IRA to a Roth IRA, which are commonly referred to as conversions.
Remember that the one-rollover-per-year rule refers to once every 12 months, not once every calendar year.
Rule 5: You Should Only Roll Assets Over From Same-Kind Accounts
Unfortunately, you don’t always have the ability to transfer funds directly from one type of retirement account to another. You can roll over from certain types to others, but not every kind of account is compatible with every other account. For example: You can roll funds from a Roth 401(k) into a Roth IRA, but not into a traditional IRA; and you can roll funds from a traditional IRA into a SIMPLE IRA, but only after two years.
These rules can be tricky to keep up with, so the IRS has put together a chart to make it easier. Most importantly, you want to transfer funds from one account to another with the same type of tax treatment, like a pre-tax 401(k) balance to a traditional IRA or a ROTH 401(k) balance to a Roth IRA.
When in doubt, consult the government’s official chart, and always discuss your plans with a tax advisor to confirm you’re making the right moves.
Rule 6: You Don’t Have to Transfer Everything
No, you are not required to roll your full balance over to your new IRA.
Granted, if you’re leaving a job and moving money from your retirement account with that company to an IRA, you may not want to leave any money behind.
But if you’re moving money from one IRA to another, it might be helpful to know that you can leave some assets in the original account if you want to.
Rule 7: You Can Roll Over Inherited Funds From Your Spouse
Rules for inherited funds differ depending on whether you’re inheriting assets from your spouse or from someone else, and sometimes they vary depending on what type of account you’re inheriting.
If you’re inheriting an account from your spouse, you can usually roll the money from their retirement account over to your own.
On the other hand, you may choose to assume the inherited IRA as your own—or you might name yourself the beneficiary and just leave all funds in their original accounts.
If you’ve inherited an account from someone other than your spouse, things are a bit more complicated. Unfortunately, you cannot treat the inherited account as your own, so rollovers aren’t an option. Some people may prefer to set up a separate inherited IRA or cash out the account and pay taxes on the money.
Rolling money over from an inherited account is complicated, so you may want to research and talk to a professional before taking action.
Rule 8: Keep the Aggregation Rule in Mind
The aggregation rule states that all your IRAs must be aggregated, or lumped together, when determining how much you owe in taxes.
This rule mainly affects people who are trying to make a backdoor Roth contribution , which is a funding process high-income earners may leverage to fund Roth IRAs. They use this method because although people aren’t allowed to contribute to a Roth IRA once they hit a certain income, there’s no income limit for people to convert a traditional IRA to a Roth IRA.
The aggregate rule makes pursuing backdoor Roth contributions trickier, because you could end up paying much more in taxes than you expected. If you want to make a backdoor Roth contribution , be sure to scrutinize all the rules, especially the aggregation rule, and speak to a tax advisor so that you don’t wind up with a larger tax bill than expected.
How to Do an IRA Rollover
Now that you know the IRA rollover rules, actually completing a rollover should be relatively easy.
First, decide which type of IRA you want to set up. If your employer provides you with an IRA, it will be a SEP or SIMPLE IRA, but if you set one up yourself, you’ll choose between a Roth and traditional IRA. There are pros and cons to each, but be sure to double-check that you can roll funds over from your original retirement account to whichever new type of account you select.
If you want to do a direct rollover, your employer can move your assets by making out a check to your IRA provider or by sending the money electronically. If you want to complete an indirect rollover, request to have the check made out to you.
If you don’t already have an IRA provider, choose the one you want to use to open your new IRA. It’s often a good idea to speak with your IRA provider if you have any questions along the way, whether you’re wondering about rollovers, transfers, or investments.
Consider SoFi as your IRA provider. SoFi offers both traditional and Roth IRAs, and you have many investment options—and zero transaction fees. With SoFi Invest®, you make the choice as to how active you want to be in the investing process. And with SoFi you always have a credentialed financial planner there to help.
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