By: Paul Horn, CFP®, CPWA®, Senior Financial Planner
For many individuals, their retirement account(s) is their largest asset outside of maybe their home. Over $500 billion is rolled over annually from workplace retirement plans to Individual Retirement Accounts(s) (IRAs). According to the Department of Labor (DOL), the decision to roll over assets from a workplace retirement plan to an IRA is often the single most important financial decision a person makes in their lifetime. Below are some of the most common errors we see people make with their IRA rollovers:
A common error we see is called an indirect rollover. This occurs when someone takes money as a lump sum to themselves instead of having the money sent directly to their new retirement account. For example, if you start a new job and want to move your old 401(k) into a new IRA the best way to do so is a direct rollover and have the money sent directly from the old 401k to the new IRA on your behalf. Unfortunately, some individuals make the mistake of having the check sent directly to them in their name instead of having the check made out to the custodian of the new account. Ideally, the checks should be made out to the custodian (i.e., Charles Schwab & Co.) FBO (shorthand for “For Benefit Of”) your name. If the check is made out into your name you trigger unnecessary taxes and have only 60 days to put the money back into your new account.
2. Unintentionally triggering the mandatory IRS 20% withholding the IRS requires for an indirect rollover.
If a person makes the first mistake, they will automatically trigger this second mistake. Anytime money comes out of the retirement account from an employer either as a indirect rollover (see above) or as a distribution to themselves (i.e. they need to take money out to pay medical bills), the IRS requires your plan administrator withhold 20% Federal taxes as part of the withdrawal. If this occurs on an indirect rollover on accident you can work with a CPA to claim this when you file your tax return for that year (most likely next April).
3. Not fully understanding the 60 Day Rollover Rule.
If a distribution from a retirement plan is paid directly to you, you can deposit all or a portion of it in an IRA or a retirement plan within 60 days. To avoid people taking money out short-term from their retirement accounts, the IRS updated the rules in 2015 and you can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own. The limit will apply by aggregating all of your IRAs, including SEP and SIMPLE IRAs as well as traditional and Roth IRAs, effectively treating them as one IRA for purposes of the limit.
The one-per year limit does not apply to:
4. Completing a rollover without completing an RMD when it is required.
If you are 72 or older and you retire, the IRS will require you to take out a portion of your 401k each year starting the year you retire, and this is known as a Required Minimum Distribution (RMD). The IRS also does not allow you to combine the RMDs from different types of retirement plans and IRAs. For example, an individual retires end of this year at age 73 with a 401k from her current employer and an IRA that she manages. The IRS will require her to take an RMD from each account, so the RMD from the IRA and the RMD from the 401k must be two separate transactions. Unfortunately, I have seen even other advisors make this mistake and complete a rollover before satisfying the RMD from the 401(k). To avoid this, you must take the RMD from the 401(k) BEFORE you initiate the rollover.
Unfortunately, it is easy to make these simple mistakes and the IRS is not very forgiving. When you are taking a distribution, it is recommended that you work with a professional to help ensure you are not making any of these mistakes. As always feel free to reach us at firstname.lastname@example.org if you have questions regarding your specific situation.
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