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Anyone who has ever filed a tax return knows that the devil is in the details when it comes to dealing with the IRS. That is doubly true when it comes to moving money from one retirement savings vehicle to another. Choosing the wrong method, or losing track of the time can trigger tax consequences that you want to avoid. If you want to give your 401(k) or savings a workout, it may be time to consider one or the other.
Here are some insights into the different ways to move your retirement savings from one account to another:
This is the term used when you move the same kind of retirement savings plan from one firm to another. For example, when James, a 51-year-old self-employed real estate agent realized that he could invest in real estate in a self-directed IRA, he moved his SEP IRA from Oak Bank to Entrust. You can do the same thing with any kind of IRA: Traditional, Roth, SEP or SIMPLE.
Transfers do not have to be reported to the IRS. They are not taxable because the assets are not paid—distributed, is the word the IRS uses—to the account holder. James’s assets moved from one firm to another. He never received the money, so he pays neither tax nor penalty.
In a rollover, the funds in an IRA are paid out directly to the account holder. Technically, this is a distribution and could be taxable and potentially subject to the early distribution penalty. If the money is re-deposited or rolled over into another tax-deferred account within 60 days, any amount rolled back will not be taxed nor penalized.
That is what Judy did when she decided to move her Traditional IRA from a community bank to a brokerage firm. While she was researching brokerage firms, she closed her IRA, got a check for the full balance and held on to it. Within two weeks, she found a firm whose advice services supported her goals and opened a new IRA with her rollover.
Rollovers are reported to the IRS, because if the account holder fails to re-invest the money in another tax-deferred account within 60 days, it is considered a distribution. That means the account holder can be liable for taxes and perhaps penalties for early distribution.
Direct rollovers involve moving money from an employer-sponsored plan—think 401(k), 403(b) or a government-sponsored 457(b) plan—into an IRA. It is called “direct” because the money is moved directly from an employer-sponsored plan into an IRA. The assets are made payable to the the IRA and not the individual.
When Terry left her job to go back to school, she didn’t want her 401(k) balance to sit around. She requested a direct rollover into a self-directed IRA with Entrust, where she had more control over the assets in her account.
This happens when an account holder decides to cash out a tax-deferred retirement savings account. That includes Traditional, SEP and SIMPLE IRAs, 401(k), 403(b) and 457(b) plans. Because most of the money in these plans have never been taxed before, the account holder typically owes the tax when the money is taken out. Depending on your age, you also may have to pay a penalty for early withdrawal.
The contributions made in a Roth IRA are contributed after tax, so there are no tax consequences or penalties for distributing the contributions. Conversions are also tax-free but may be subject to a penalty. Earnings on a Roth on the otherhand may be distributed tax-free if the Roth IRA holder has had a funded Roth IRA for 5 years and the distribution occurs after attaining age 59 ½, death, disability or purchasing a primary residence ( max $10,000).
Taking a distribution from these retirement plans will stop your opportunity to see your investments grow tax-deferred over time.
Use the Right Transaction
Understanding the differences among these transactions is essential to minimize the potential for errors in the transaction process and to ensure you maintain the tax-advantages status of your retirement savings.
Diversify your savings by giving your current account a workout with Entrust. Learn how you can open an account in under 10 minutes here.