The Process of Moving Company Plan Funds to a Roth IRA

Tuesday, January 20, 2015

By Joe Cicchinelli, IRA Technical Expert
Follow Me on Twitter: @JoeCiccEdSlott

When we think of retirement plan rollovers, we usually think about moving money between IRAs, or moving money from a company retirement plan to an IRA on a tax-free basis. For example, if you properly roll over money within 60 days from your IRA to another IRA or from your Roth IRA to another Roth IRA, the rollover is tax-free. Or maybe you retired and rolled over your 401(k) funds to your IRA. That rollover is also tax-free. But there is one type of rollover that is taxable; and that is when you roll over company retirement plan money to your Roth IRA.

Since 2008, the tax code has allowed you to roll over your company retirement plan money directly to a Roth IRA. Before 2008, you had to first roll over the funds to your IRA and then convert your IRA to a Roth IRA. Most of you know that converting IRA funds to a Roth IRA is a taxable transaction. If it wasn’t, all of us would convert our IRAs to a Roth IRA and let the funds grow tax-free inside the Roth IRA. Then later we could take tax-free distributions from the Roth IRA. Just as converting IRA funds to a Roth IRA creates a taxable transaction, so to does the rollover from a company retirement plan to a Roth IRA.

When you become entitled to receive a distribution from your company retirement plan, you must be given the option to directly roll over the funds to an IRA or to a Roth IRA. The rollover of pre-tax funds to your IRA is tax-free, but distributions of those funds later on will be taxable to you. In contrast, a rollover of pre-tax funds from your company plan to a Roth IRA is taxable at the time of the rollover because it is treated as a conversion to a Roth IRA. No 10% early distribution penalty will apply even if you’re under age 59 ½ at the time of the rollover. Just like an IRA-to-Roth-IRA conversion, the funds can grow tax-free inside the Roth IRA and distributions of earnings can be taken out tax-free if they are qualified.

So make sure to tell your tax-preparer if you rolled over company retirement plan money to a Roth IRA because you will owe income taxes on that rollover. IRS will know you did a conversion because the 5498 issued by the Roth IRA will tell them.

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