One of the biggest mistakes consumers make is in the area of IRA rollovers. Typically, when this happens, paperwork is generated by the trustee of the plan so the funds may be rolled over to an IRA. A rollover may be done once per year, and, if done correctly, it may be done tax- free. A person can roll money into an IRA while still employed.
Proper procedures
must be in place for a rollover to be considered tax- free. A rollover will not be considered tax- free if the proceeds are made payable directly to the participant. In this case, when the check is made payable directly to the participant, the trustee is required to withhold 20% for income taxes. In order to be considered a tax- free rollover, the check must be made payable to the new trustee of either the IRA or the qualified plan to where the funds are being transferred. For example, the transferring trustee would be notified that the check should be made payable to the “ABC trustee FBO (for the benefit of) John Client.” In this example, ABC is the trustee of the new IRA or other qualified retirement plan. Having the check drawn in this manner helps assure the rollover will be tax- free. Typically, the check is sent to the address of record for the client to deposit in the appropriate account. Please note the check does NOT have to be endorsed, since it is not payable directly to the client, but rather to the trustee of the new account. This area has confused many people in the past.
Rollovers
typically generate a form 1099-R in January of the year following the rollover. Please note that a 1099-R is different from a form 1099. A 1099-R must be noted on your 1040 on line 15 (a,b). Assuming that nothing was withdrawn, a “0” is placed on line 15 (a,b), more informationwhich denotes the rollover to be tax-free. Please note that any unpaid 401(k) loan is considered a taxable event, and will be taxed in the current tax year with applicable early withdrawal penalties. If there is a loan on your account, we would suggest that you pay it back PRIOR to doing a rollover, so you do not suffer these adverse tax circumstances. While a rollover is not required, even if you change employers, we would suggest strongly that this be done, since it allows you to control which investments you will choose.
IRA transfers
are looked at differently. For example, if you have an IRA in a CD at your local community bank and wish to transfer it to a mutual fund, this can be accomplished in two different ways. First, the monies can always be transferred on a trustee-to-trustee basis; simply go to the community bank, fill out the requisite paperwork and the asset should be transferred timely. Another way is to take advantage of the “60 day rule.” You can go to the bank and have them make the check payable directly to you, and you then have 60 days to deposit the EXACT amount into your new IRA. This will not be considered a taxable event. You will have to account for it the same way as an IRA rollover, as listed above, but the bank does not have to withhold 20% for income taxes. The advantage of the 60 day rule is that you have the use of the money for 60 days. Remember, when you write the check to the new trustee, do not “round up” or “round down,” since it may be considered a premature distribution or an excess contribution, depending upon the circumstances. Make the check payable for the EXACT amount. Please note that if you choose the second option you run the risk of missing any returns you may have received had you left it invested.
There are semantical differences in doing a rollover or a transfer. Having a complete understanding of the law should allow you to make the proper decision.