Don’t Risk an IRA Rollover Mistake

When the unemployment rate creeps upward, more people face an important decision about what to do with their retirement savings.

People who are laid off or entering retirement often find that a former employer’s retirement plan can be an unwelcome place to keep their money. Layoff notices are often followed with a deadline to withdraw retirement assets from the company plan because the employer is no longer willing to bear the cost. People who have retired may find that their former employer’s plan doesn’t offer the flexibility or investment options they need to pursue their post-retirement goals.

Fortunately, there is an alternative: By rolling retirement assets into an IRA, it’s possible to preserve their tax-deferred status. When a rollover to a traditional IRA is performed correctly, there should be no tax consequences, no tax penalties, and, in most cases, no out-of-pocket expense to the account owner.

Federal tax law allows for more than one way to execute a rollover. But did you know it’s possible to do it legally and still run into complications which can include having to come up with a large cash payment?

Once you leave a job, your employer’s retirement plan administrator may send you paperwork to begin the process of moving your retirement money out of the plan. You are likely to be given the option of simply receiving a check made out in your name.   You then have 60 days to deposit the check in a traditional IRA.

This is what’s known as an indirect rollover, and although it sounds easy -  two months is usually enough time to open an IRA - things can happen to slow the process down.

Double Jeopardy: The Withholding Trap

If the plan administrator makes the check out in your name, it is required to withhold 20% of the rollover amount, for the same reason your employer withheld a portion of your pay:  in anticipation of income taxes. 

Even though you are conducting a transaction that does not have any intended tax consequences, the IRS doesn’t trust you to follow through. You might decide to spend all or part of the money. You could miss the 60- day deadline. You might deposit the check in the wrong type of account. Any one of these actions would be considered a taxable event and you could incur an income tax liability (plus a 10% federal income tax penalty if you are younger than age 59½).

For example, let’s say that you have $100,000 in your former employer’s 401(k) plan, and you advise the plan administrator that you wish to conduct an indirect rollover. A week or so later, you get a check in the mail for $80,000. In order to successfully execute this rollover, you need to deposit $100,000 in a traditional IRA within 60 days. If you don’t have the extra money to make up the difference, you will owe ordinary income taxes on $20,000 plus a $2,000 penalty if you are younger than 59½.

You may be able to prevent the employer plan from withholding 20% by having the check made out to the new IRA custodian. But most experts would tell you that you are still leaving an unnecessary margin for error whenever the money from an IRA rollover passes through your hands.  It's knowing what to do and how to do it properly. 

 We at Diversified Financial Services, can help you conduct a direct rollover and greatly reduce the potential for mistakes that result in an unplanned tax liability or costly tax penalties.  We are 'IRA Rollover Specialists' and can also show you how to pass your IRA on to your heirs and beneficiaries without the huge tax implications to them.  Please call us for help!

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.  This material was written and prepared by StoneRiver–Emerald.     © 2009 StoneRiver, Inc.

lease note that we at Diversified Financial Services are IRA Rollover Specialists and will be happy to answer your questions regarding your specific needs and objectives and can show you how you can pass your IRA on to your heirs and beneficiaries without huge tax implications to them.