What is a Retirement Plan Rollover?

By Beverly DeVeny, Chief IRA Analyst 
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What is a Retirement Plan Rollover?

The word “rollover” is used frequently in writing and talking about distributions from retirement plans. Many times it is used incorrectly. It is critical that retirement account owners and their advisors know the meaning of the word rollover.

You can blame Congress for the confusion over just what exactly is a rollover. There is the IRA rollover which is different than the employer plan rollover.

All rollovers are tax reportable transactions. The company making the distribution must issue a 1099-R for the distribution. The company receiving the rollover must issue a 5498 showing the receipt of the rollover funds.

The IRA Rollover

In the IRA world a rollover is always a 60-day rollover. It can only occur when a distribution from the IRA is made payable to the IRA owner. As long as the IRA owner is not yet 70 ½, then the IRA owner has 60 days to complete a rollover of the funds to either an IRA or an employer retirement plan. When the rollover is accomplished within the 60 days, then the IRA owner has a non-taxable event.

When the IRA owner is age 70 ½ or older during the year, then the required minimum distribution (RMD) amount for the distributing IRA cannot be rolled over. Any amount over and above the RMD can be rolled over within the 60 days.

IRA-to-IRA and Roth IRA-to-Roth IRA 60-day rollovers are subject to the once-per-year rule. Individuals can do only one of these rollovers in a 12 month period. It is no longer one per account and it is not one IRA and one Roth IRA rollover. It is only one 60-day rollover every 12 months.

The Employer Plan Rollover

The tax code calls any distribution from an employer plan a rollover. It can be a direct rollover which goes directly from the employer plan to another retirement account or it can be an indirect (60-day) rollover. In either case, if the plan participant is age 70 ½ or older during the year, the plan should issue a separate check for the year’s RMD. This RMD check cannot be rolled over.

A direct rollover can be a check issued to the new account but the check is sent to the plan participant for delivery to the new account. Since the plan participant cannot cash the check, this transaction is a direct rollover. It is a non-taxable transaction.

An indirect or 60-day rollover is a distribution made payable to the plan participant. They can cash this check. The plan participant has 60 days to rollover the funds to another retirement account. When the rollover is accomplished within the 60 days, it is a non-taxable event.

There is a “gotcha” that comes along with an employer plan 60-day rollover. The employer plan must withhold 20% of the taxable amount of the distribution for taxes. The plan participant can make up the withholding amount from other funds and roll the withholding amount into another retirement plan within the 60 days. If the withheld amount is not made up, then the plan participant has a taxable distribution of the withheld funds.

Example:  Pam has $100,000 of pre-tax funds in her 401(k) account. She requests a distribution, payable to herself, of the $100,000. The employer must do 20% mandatory withholding in the amount of $20,000 ($100,000 X 20% = $20,000). Pam receives a check in the net amount of $80,000 ($100,000 – $20,000 = $80,000). Pam can add $20,000 of personal funds to the $80,000 received from the plan and do a complete rollover within 60 days of the total amount of her plan balance. Then Pam has a tax-free transaction. If Pam only rolls over the $80,000 she received from the plan, then she has a taxable distribution in the amount of $20,000 which is the amount withheld for taxes and not rolled over.

Now you know the difference between a rollover and a rollover. Be sure you use the terms correctly and know when others are using the term incorrectly. An incorrect use of the term could result in significant tax and penalties for the account owner. To make life simpler, use direct transfers whenever possible. There is no mandatory withholding and no once-per-year rule to worry about.