Seven Common Rollover Mistakes

Seven Common Rollover Mistakes

If you are changing jobs or looking to retire in the near-term, make sure you take your money with you and avoid any negative tax consequences.  Life doesn’t stop and rather than losing track of an old retirement plan, transfer your retirement savings to an IRA immediately when you are going through a change.  In most situations, we recommend that you do not cash in your retirement plans prior to age 59 ½, as you will have both taxes and IRS penalties assessed to an early withdrawal.  Rather, rollover your retirement plan to an IRA.  Here are seven common mistakes that can be avoided.

1. Rollover Within 60 days

If you are electing to do a rollover, the rollover clock starts when the money is distributed from the 401(k) and you will have 60 days to deposit the rollover proceeds into your IRA.  If you miss the deadline, the entire balance will be taxable and if you are under the age of 59 ½ and additional 10% penalty will be accessed.

2. Distributions Prior to Age 59 ½

The IRS does allow you to take distributions from your retirement accounts prior to age 59 ½ through a IRS provision 72(t), thus being able to avoid the 10% early withdrawal penalty.  To qualify and avoid the early withdrawal penalty, the withdrawals must be a series of substantially equal periodic payments.  Retirees can begin a 72(t) payment schedule from an IRA at any age, even if they are still working, but must adhere to the rules to maintain the tax preference.  The withdrawals must continue for at least five years or until age 59½, whichever period is longer and the distributions cannot be rolled into another retirement plan.  You may not modify the agreed-upon schedule or account.  And if you violate this contract, then the 10% penalty will apply to all distributions taken prior to age 59 ½.  This is known as the recapture penalty, which can be a substantial tax hit.

3. Unpaid Plan Loans

Your 401(k) plan may allow you to take a loan and pay it back over a certain period of time.  If you leave your employer, the loan will need to be paid back or the remaining balance will be deemed a distribution.  The 401(k) plan will report the outstanding loan balance on Form 1099-R and the distribution is taxable and may be subject to the 10% early distribution penalty.  We suggest if you are in this situation and considering leaving your employer, work with your human resources department on how the best way to pay the loan back.

4. Hardship Distributions

Some 401(k) plans allow participants to take withdrawals for financial hardships and emergencies.  If the retirement plan permits these distributions, note that they will be taxable, but if the hardship qualifies for one of the exceptions, there is not a 10% early withdrawal penalty.  However, hardship withdrawals cannot be rolled over.

5. Required Minimum Distribution (RMDs)

The IRS requires distributions from retirement plans to begin at 72 years old.  Unfortunately, like hardship withdrawals, RMDs are not eligible to be rolled over.  It is a common mistake and if you rollover your RMDs, they become an excess IRA contribution subject to the six percent penalty, unless it is removed by October 15 of the year following the year of the excess contributions.

6. Rollover Like Property

Most 401k plans will distribute the rollover in the form of a check or cash transfer and thus be deposited into the new retirement plan.  But in the event, you withdrawal stock from an IRA, then only that stock is eligible to be rolled back over.  Therefore, you cannot withdrawal stock from your IRA and then deposit cash into your new IRA.  It must be the same property; otherwise, it cannot be rolled over.

7. Divorce

An expensive mistake in divorce is when IRA funds split in a divorce are withdrawn, those funds are taxable and cannot be rolled over to the ex-spouse’s IRA. To avoid this mistake, 401(k) and IRA funds should be moved from one spouse’s retirement plan to the other’s via a tax-free direct transfer.  This is often done via a Qualified Domestic Relations Order (QDRO).

Your life and needs change.  If you are faced with how to best transition retirement assets, we suggest talking with us first to avoid any adverse tax consequences.

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