Unless you have the right training, credentials and errors and omissions insurance, you should probably not go into much detail with clients about the tax implications of retirement plan rollovers. But you may need to know something about the tax rules for rollovers just to stay out of trouble, and to hold your own in conversations with accountants and tax lawyers.
Here's a look at some key retirement plan rollover basics from a team of compliance experts.
Tax-free rollovers of distributions from qualified plans, individual retirement arrangements (IRAs) and other retirement plans allow the continuation of the tax deferral of the earnings generated by these plans.
Generally, an "eligible rollover distribution" is rolled over to an "eligible retirement plan."
However, if the individual fails to transfer the eligible rollover distribution to an eligible retirement plan no later than the 60th day following the day of receipt, such amount would be included in gross income subject to tax.
Rollovers from qualified plans do not need to be converted to cash prior to completing the rollover. Stock, bonds, mutual fund shares or other noncash property may be rolled over without being sold.
Here are four rollover situations that might be of interest to financial professionals.
1. When a Participant Receives a Distribution from a Qualified Retirement Plan
If the participant receives a distribution from a Qualified Retirement Plan, it must be rolled over to an eligible retirement plan within sixty days after the funds are received. The sixty-day period begins on the day after the distribution is received. If the sixtieth day falls on a weekend or legal holiday, the next business day will be considered the last day for the rollover to occur.
An eligible retirement plan generally includes any of the following:
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a traditional IRA,
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a qualified pension, profit sharing or stock bonus plan,
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an eligible Section 457 governmental plan (if certain separate accounting requirements are met), and
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a Section 403(b) plan.
An eligible rollover distribution is any distribution to a participant of all or part of his or her account balance in a qualified retirement plan that is not:
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part of a series of substantially equal periodic payments made at least annually over (a) the life or life expectancy of the participant or the joint life expectancies of the participant and designated beneficiary or (b) a specified period of ten years or more – the test is applied at the beginning of the payout period,
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a minimum required distribution
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the nontaxable portion of a distribution unless made to a traditional IRA or a qualified plan and certain requirements are met,
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the excess 401(k) annual additions of elective deferrals that are returned due to Code Section 415 limitations,
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corrective distributions of excess contributions, deferrals or aggregate contributions along with the income allocable to the corrective distributions under a 401(k) plan,
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distributions to a beneficiary other than a surviving spouse or a current or former spouse under a qualified domestic relations order,
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hardship distributions, or
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deemed distributions of plan loans.
The downside of an eligible rollover distribution paid directly to the participant is the 20% federal income tax withholding.
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Additionally, state income tax withholding may be required. On the other hand, if the distribution is rolled over directly to the eligible retirement plan, there is no withholding requirement. A direct rollover may be in the form of a trustee-to-trustee transfer accomplished through a wire transfer or a check made payable to the trustee.
2. When a Client Wants to Make Temporary Use of Rollover Distributions
Due to a temporary lack of funds, some participants use all or part of an eligible rollover intending to replenish those funds prior to the expiration of the 60-day period. In that case, the participant risks adverse tax consequences should he or she be unable to roll over the full amount of the distribution within that period.
