What is a Rollover IRA?

Simply put, a rollover is the transfer of your retirement savings from your old employer-sponsored retirement account to an IRA. The receiving IRA account is your Rollover IRA.

With an IRA rollover, you can maintain the tax-deferred status of your retirement assets without paying taxes or penalties at the time of transfer.

You may want to initiate an IRA rollover for any number of reasons—your employment situation has changed, you want to switch investments, or you’ve received death benefits from your spouse’s retirement plan.

In general, the following types of plans allow rollovers:

How long do I have to roll over my 401(k) from a previous employer?

It depends. 

• If you have less than $5,000 in your account, your old employer is legally allowed to require you to transfer your money out of that retirement plan. (It costs them money to maintain your account, after all.)
• If you contributed between $1,000 and $5,000, your employer might perform an involuntary cashout by moving your money into an IRA.
• If you have less than $1,000 in the account, they’ll likely cut you a check for the appropriate amount—in which case you should deposit it into another retirement account ASAP so that you don’t get hit with a penalty from the IRS.

You get to keep your employer matches only if the contributions had vested prior to your departure. Your old employer retains all unvested contributions.

Now, your 401(k) contributions can stay put in your old account, but does that mean they should? You’ll likely find it preferable to track your investment performance in one account versus managing investments across several accounts.

How can I roll over my 401(k) to the Rollover IRA?

If you decide to roll over an old retirement account, you can transfer funds directly or indirectly via:

• An indirect (60-day) rollover
• A direct rollover (trustee-to-trustee transfer)

The indirect, or 60-day, rollover

With an indirect rollover, you can request that your old employer make a check out to your name. Then, to complete the transaction, you can deposit your funds into your new retirement account. 

One inconvenience is the mandatory tax withholding—your employer assumes you are cashing out the account, so they’re required to withhold 20 percent of the funds for federal taxes. As a result, your $100,000 401(k) nest egg is reduced to an $80,000 check. 

If you want to roll over the entire distribution amount (and avoid taxes and possible penalties on the amount withheld), you’ll need to come up with that extra $20,000. Of course, you’ll be able to recover the withheld amount upon filing your tax return.

After receiving your check, you have 60 days to deposit the full amount into a new retirement account. Assuming you haven’t reached age 59 ½, missing the 60-day limit could result in a mandatory 10 percent early withdrawal penalty. The $20,000 mandatory tax withholding must be reported on your tax return—and could push you into a higher tax bracket.

The indirect rollover only makes sense if you need to use your funds temporarily, are certain that you can complete the rollover within 60 days, and can foot the cost of your withheld amount. 

For most rollovers, the direct method is the most efficient option.

The direct rollover, or trustee-to-trustee transfer

Direct rollovers protect you from two key traps:

• Missing the 60-day deadline, and
• The 20 percent mandatory tax withholding

With a direct rollover, you don’t have to handle your retirement assets, which means your transfer is not treated as a distribution. Simply connect the trustees or custodians of your old and new plan, then your plan administrators will complete your rollover electronically. 

Your employer is required to give you the option of a direct rollover to another retirement plan.

How long does a rollover take?

If you opt for a direct (60-day) rollover, you have 60 days—not two months—to complete the rollover. Under certain circumstances, you can apply for a waiver or extension of the 60-day period from the IRS.

A direct rollover (trustee-to-trustee transfer) takes about 2 to 3 weeks from start to finish. 

How many rollovers can I do in a year?

You’re limited to one tax-free rollover per 12-month period. This applies to all IRA accounts you may own.

There are some exception to the one-rollover-per-year rule:

• You can roll over more than one distribution from the same qualified plan, 403(b), or 457(b) account within a year.
• The once-per-year limit does not apply to rollovers from traditional IRAs to Roth IRAs (e.g., Roth conversions).

What’s the difference between an IRA rollover and transfer?

If you’re switching your IRA balance between providers, use the transfer method instead of a rollover. 

A transfer is non-reportable and can be done an unlimited number of times during any period. Just call your current provider and request a “trustee-to-trustee transfer.” This moves money directly from one financial institution to another, and it won't trigger taxes.

A transfer removes the withdrawal process of the rollover, so your assets will move directly into your new account. You won’t be subject to the 60-day rule.

Why should I do an IRA rollover?

Rolling over your 401(k) to an IRA might be a good option if you want:

• More, and more flexible, investment choices
• Better communication
• Lower fees
• The potential to open a Roth account
• Cash incentives
• Fewer rules
• Estate planning advantages
• Flexibility for withdrawals

Advantage #1: You want more, and more flexible, investment choices.

Your 401(k) plan is limited to those selected by your employer. 

If you’re closer to retirement, most 401(k)s are weaker when it comes to fixed-income options. In all likelihood, you have the choice of a money market fund, a bond index fund, and an actively managed bond fund—and that's it. Rolling your money into an IRA will provide you with many more fixed-income options, including international bond funds and CDs.

In contrast, you can invest in virtually anything with your IRA. Most types of investments are available to you—mutual funds, individual stocks, bonds, and ETFs, to name just a few. You can even hold investment real estate in your IRA.

You’re also able to make trades whenever you want. Most 401(k)s limit the number of times per year you can rebalance your portfolio, or restrict you to buying and selling during certain times of the year.

Advantage #2: You want clearer communication.

If you leave your account with your old employer, you’ll have to put in more effort to receive updates or get in contact with a 401(k) advisor or administrator. This could be problematic if, for instance, your former employer goes into bankruptcy.

Advantage #3: You want the Roth option.

You can roll over your retirement funds from your employer-sponsored plan to a traditional or Roth IRA. Everyone is eligible for a Roth IRA conversion. Remember that you must pay ordinary income taxes in the year of the conversion on all tax-deferred assets converted to a Roth IRA. 

Note that your eligibility to contribute to a Roth IRA phases out at higher modified gross income levels. As a single filer, your Modified Adjusted Gross Income (MAGI) must be under $139,000 in 2020 to contribute to a Roth IRA. If you're married and filing jointly, your MAGI must be under $206,000 in 2020.

Qualified distributions from a Roth IRA are tax-free, but you may have to pay state, local, and alternative minimum taxes. To be able to withdraw your earnings on a tax- and penalty-free basis, your Roth IRA must meet the five-year holding requirement. Additionally, you must withdraw after age 59 ½ or for qualified reasons, including death, disability, or a first-time home purchase.

Advantage #4: You want to pay less in fees & costs.

Many 401(k)s are hampered by high fees and underperforming investments. It’s possible that the funds offered through a 401(k) are higher-than-average for their asset class. 

You’re also paying for the annual fee charged by your 401(k) plan administrator. And as a former employee, you might be charged higher administrative fees for keeping your old 401(k).

You could potentially save a lot in management fees, administrative fees, and fund expense ratios—all of which can shrink your nest egg over time—by rolling over into an IRA. With an IRA, you have more choices and more control over how to invest, where to invest, and what you'll pay.

Advantage #5: You could use the cash incentives.

To entice investors, firms may offer a cash bonus to encourage you to sign up with them. For instance, TD Ameritrade offers bonuses ranging from $100 to $2,500 when you roll over your 401(k) to one of its IRAs, depending on the amount you have to invest. 

Other perks include matches and bonuses, such as free trades.

Advantage #6: You prefer fewer rules.

It’s no secret that 401(k)s are complicated. Companies are free to set up 401(k) rules and regulations however they like. On the other hand, all IRAs follow rules set by the IRS. Brokers must follow the same governing rules with all IRAs.

It’s important to note that the IRS has different rules for 401(k) and IRA distributions. 20 percent of 401(k) distributions are withheld for federal taxes. Conversely, you can choose to have no tax withheld on IRA distributions. It goes without saying that you should have some tax withheld, which is vastly preferable to winding up with a big tax bill at the end of the year—and possibly interest and penalties for underpayment.

The big advantage is your choice of how much to have withheld. Rather than an automatic 20 percent—thus depleting your retirement returns unnecessarily—you can choose an amount that more accurately reflects the actual amount that you owe.

Advantage #7: You want the estate planning advantages.

Upon your passing, most companies prefer to distribute your 401(k) in one lump sum to your beneficiary so they don’t have to maintain your account. Without proper planning, you run the risk of having income and inheritance tax problems. IRAs offer more payout options in comparison.

401(k) plans typically require your spouse to be the primary beneficiary. Unlike 401(k)s, IRAs allow you to designate non-spousal beneficiaries. 

If you don’t plan to use your 401(k) funds in retirement, and you’d like to leave your money to your children, consider rolling over into an IRA so your kids can "stretch" the account and pay taxes at a later period than under the 401(k).

Advantage #8: You want flexibility for withdrawals.

Most large 401(k) plans permit retirees to take withdrawals in one of two ways:

1. On a regular basis (for instance, monthly or quarterly), or
2. Whenever they want

But for the unlucky few who have an “all-or-nothing” requirement, you might need to leave all your money in the plan or withdraw all your funds. In this case, opt for an IRA rollover to manage your withdrawals and taxes.

Even if your 401(k) plan permits monthly or quarterly withdrawals, many plan administrators don’t allow you to pick and choose which investments to sell—instead, they take an equal amount out of each of your investments. With an IRA, you can specify whether you’d like to take the entire amount out of a specific fund and leave the remainder of your retirement assets to grow.

Finally, the distribution options in an IRA are generally more flexible than the options available in your employer-sponsored plan—especially for your beneficiary, in the event of your passing.

We Can Help

Prosperity Financial Group specializes in helping clients like you grow their retirement accounts.

If you’re ready to roll over your 401(k) into an IRA, or if you have any questions about a 401(k) rollover, please fill out the form below and we’ll get back to you shortly. We look forward to hearing from you.

DISCLAIMER: Advisory Services offered through Prosperity Financial Group, Inc., an Independent Registered Investment Advisor. Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Prosperity Financial Group, Inc. and Fortune Financial Services, Inc. are separate entities.