Retirement Plan Rollover Basics

There are certain guidelines that must be adhered to when rolling over retirement plan assets to an IRA or another qualified plan.

Retirement plan participants may choose a direct rollover, where the distributing plan sends the eligible distribution to the trustee or custodian of the recipient IRA or plan. This method does not require any withholding of taxes, and the participant never handles the funds.

If a participant receives a distribution from the retirement plan, he has 60 days to decide whether to roll the money into a new plan or IRA. “This gives the participant time to decide whether to keep the funds as a taxable distribution or roll over the amount to preserve the tax-advantaged status,” says Bob Kaplan, national retirement consultant for retirement solutions at Voya Financial. He warns, “If a participant fails to do so within the 60 days, the amount not rolled over is then subject to taxation, including penalties that may apply if the individual is under the age of 59½.”

When the participant receives the distribution, 20% of the pre-tax amount is taken as taxes and sent to the Internal Revenue Service (IRS). “If the participant decides to complete the rollover, the amount distributed [the 80%] can be rolled over and the participant can also roll the cash equivalent of the 20% that was sent to the IRS,” Kaplan says. If the participant decides to send the gross distribution amount to a new plan or IRA, he would have to fund the amount that was taken as taxes and sent to the IRS, but would not have to report any of the distribution as taxable income on his annual tax return, so he would get back the taxes originally taken from the distribution.

Rollover distributions are allowed from any type of retirement plan or IRA, but there are some restrictions on plans to which a rollover may be made. The rules for allowable rollovers are detailed in a Rollover Chart provided by the IRS.  

“A participant who receives an eligible distribution has the right to roll over the amount to a tax-deferred vehicle; however, qualified plans are not required by law to have a provision to accept rollovers,” Kaplan explains. “Not all plans accept rollovers, so participants who want to roll funds to a qualified plan must check with that plan’s administrator before making the transaction.” If the new plan does not accept rollovers, the participant would have to roll the amount into an IRA.

According to the IRS, the following retirement plan distributions are not eligible for rollover:

• Hardship withdrawals;
• Corrective distributions for failed discrimination tests;
• Permissive withdrawals of deferrals within 90 days from an eligible automatic contribution arrangement (EACA);
• A payment from a series of substantially equal payments;
• Required minimum distributions (RMDs) (both 70½ and death benefit);
• Loans that are treated as distributions;
• Distributions to pay for accident, health or life insurance;
• Dividends on employer securities; or
• S corporation allocations treated as deemed distributions.

 Kaplan describes a situation in which a defined benefit (DB) plan is paying a retiree an annual annuity (substantial equal payments). “Those would not be eligible [for rollover],” he says. “However, a lump sum from the same plan would be eligible. The key item to keep in mind is not the type of plan where the distribution is coming from, but rather the type of distribution.”

Participant loans are eligible for rollover and, if rolled over, would not be treated as distributions. However, rolling over loans from one qualified plan to another is contingent upon the receiving plan allowing for loans and accepting rollovers. Additionally, if a participant is paid directly (a 60-day rollover option) and part of the taxable distribution is a loan, the cash equivalent of the loan amount may be rolled to a new plan or IRA.

Recent Changes to Rollover Rules  

There are additional special rules regarding the proration of pre-tax and after-tax accounts when a participant takes a rollover. “Effective with the release of IRS Notice 2014-54, participants now have much more flexibility when their accounts being distributed have an after-tax component to them,” Kaplan observes.

Instead of having to prorate each distribution with both pre-tax and after-tax dollars, as was the rule prior to the change, the following approaches may be taken:

• The entire pre-tax amount is considered to have been rolled over if the pre-tax amount of the account being distributed is less than the amount rolled over. The amount in excess of the pre-tax funds is considered a Roth after-tax account rollover.
• If there are multiple rollovers from the same source, the participant may allocate the amounts between rollovers. According to Kaplan, “This also leads the way for participants to roll over the pre-tax and take a distribution of the after-tax or convert the after-tax to a Roth,” which will have no tax consequences.
• When there are both direct and 60-day rollovers from the same source, the pre-tax amounts are allocated first to the direct rollovers. Kaplan notes, “The amount assigned to the 60-day rollover will not have tax implications if it is all after-tax dollars.”
• If less than all of the pre-tax funds are rolled over, the participant pays tax on the pre-tax portion of the distribution that is not rolled over.

Rollover Rules for Beneficiaries  

If a participant dies, only a spouse may roll over an inherited benefit to either that person’s own IRA or qualified plan (assuming the plan has a provision to accept rollovers), Kaplan says. The spousal beneficiary also has the option of leaving the funds in the account until the participant would have turned 70½, take a lifetime annuity or a lump sum.

Kaplan says a designated non-spouse beneficiary has three options: 1) have the entire account distributed by the end of the fifth year containing the anniversary of the accountholder’s death; 2) initiate a lifetime payment annuity by the of the year following the death of the accountholder; or 3) initiate a direct rollover to an inherited IRA. However, he notes, the required minimum distribution rules follow the money—if RMDs had started from the participant’s account, they must continue to the beneficiary, recalculated based on the beneficiary’s life expectancy. The IRA is not treated as the beneficiary’s IRA and must be identified with both the deceased’s name and the beneficiary’s name. The non-spouse beneficiary may not roll over the amount to another IRA in his or her own name or to a qualified plan.