How Well Do You Understand Rollover Rules?

When leaving an employer, you generally have several options for your 401(k) plan dollars. In addition to rolling money into an IRA and leaving the money in your current plan (if the plan balance is more than $5,000), you may be able to roll the money into a new employer's plan or take a cash distribution, which could result in a 10% tax penalty (in addition to ordinary income taxes) on the taxable portion, unless an exception applies.

Sounds straightforward, right? But, in reality, it isn’t. There are many rollover-related rules, and some of them can be quite complicated. Take the following true-or-false quiz to see how well you understand some of the finer points.

 

1. Your former employer needs your permission before closing your 401(k) account.  

A. True

B. False

C. It depends

C. It depends. Generally, if your retirement account with a former employer is worth more than $5,000, the plan administrator must get your permission before closing your account and distributing the assets to you. If the balance is less than $5,000, the employer doesn't need your permission to close your account. They must, however, notify you in advance and ask you whether you want the distribution paid to you (which could be a taxable event) or have it rolled over into another retirement plan or IRA. If the amount to be distributed is over $1,000 and you don’t choose to either receive the distribution directly or roll it over into another retirement plan or Rollover IRA, the plan administrator must transfer the distribution into a Rollover IRA with a designated Trustee and inform you of this action.

 

2. You can make an unlimited number of retirement plan rollovers per year.

A. True

B. False

C. It depends

Answer: C. It depends. Rollovers can be made in two ways — through a direct rollover, also known as a trustee-to-trustee transfer, in which you authorize the funds to be transferred directly from one account or institution to another, or through an indirect rollover, in which you receive a check in your name (less a required tax withholding) and then reinvest the full amount (including the amount withheld) in a tax-deferred account within 60 days. If the full amount is not reinvested, the outstanding amounts will be considered a distribution and taxed accordingly, including any applicable penalty. Generally, individuals can make an unlimited number of rollovers in a 12-month period, either direct or indirect, involving employer-sponsored plans, as well as an unlimited number of direct rollovers between IRAs; however, only one indirect (60-day) rollover between two IRAs is permitted within a 12-month period

 

3. If you roll money from a Roth 401(k) to a Roth IRA, you can take a tax-free distribution from the Roth IRA immediately as long as you have reached age 59½.

A. True

B. False

C. It depends

Answer: C. It depends. Beware of the five-year rule as it applies to Roth IRAs. If you establish your first Roth IRA with your Roth 401(k) rollover dollars, you will have to wait five years to make a qualified withdrawal from the Roth IRA, regardless of how long you've held the money in your Roth 401(k) account, even if you are over 59½. However, if you have already met the five-year holding requirement with any Roth IRA, you may take a tax-free, qualified withdrawal.

 

4. You can withdraw money penalty-free from both your 401(k) and IRA (Roth or traditional) to help pay for your children's college tuition or to pay for health insurance in the event of a layoff.

A. True

B. False

C. It depends

Answer: B. False. You can take penalty-free withdrawals from an IRA, but not from a 401(k) plan, to pay for a child's qualifying education expenses or to pay for health insurance premiums in the event of a job loss. Note that ordinary income taxes will still apply to the taxable portion of the distribution, unless it's from a Roth account that is otherwise qualified for tax-free withdrawals.

 

5. If you retire or otherwise leave your employer after age 55, you can take penalty-free distributions from your 401(k) plan. You can't do that if you roll 401(k) assets into an IRA.

A. True

B. False

C. It depends

Answer: A. True. If you leave your employer after you reach age 55, you may want to consider carefully whether to roll your money into an IRA. Although IRAs may offer some advantages over employer-sponsored plans — such as a potentially broader offering of investment vehicles — you generally cannot take penalty-free distributions from an IRA between age 55 and 59½, as you can from a 401(k) plan if you separate from service. If you might need to access funds before age 59½, you could leave at least some of your money in your employer plan, if allowed.

If any of these situations apply to you—or if you think they may apply to you in the near future—you may want to speak to a financial advisor, who can help walk you through the process for any actions you wish to take.

 

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Joelle Spear is a financial advisor and Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. She offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. She can be reached at 508.598.1082 or [email protected]

 

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2021. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual's personal circumstances.