Tax Consequences of an IRA Rollover

by Bob Haring

An individual retirement account rollover is a transfer of assets from one retirement savings plan to another. It's done most often when an employee changes jobs and wants to change from an employer-sponsored plan to an IRA or when a saver prefers to move tax-deferred retirement funds into a Roth account whose retirement distributions won't be taxed. Some rollovers are tax-free, but others can have tax consequences.

Tax-Exempt Rollovers

Rollovers between comparable retirement accounts are generally exempt from taxes. That is, an individual can roll over a traditional 401(k) or similar employer-based plan into a traditional IRA, because both accounts are tax-deferred. Similarly, a Roth 401(k) can be converted to a Roth IRA without problem because both are funded with after-tax money.

Taxable Rollovers

A rollover from a traditional tax-deferred account to a Roth plan is subject to tax as ordinary income. Some high-income taxpayers opt for this despite tax consequences because it will reduce taxes after retirement, when Roth withdrawals are tax-exempt, while distributions from traditional plans will still be subject to income taxes.

Direct Transfers

A "direct rollover" or trustee-to-trustee transfer from a tax-deferred plan to an IRA will avoid any tax consequences. This is one with the institution holding an account moving money directly into an account at another institution without funds passing through the account holder. The original institution must withhold 20 percent of the funds if they are distributed to an account holder, who then has 60 days to deposit them into an IRA without a 10 percent early withdrawal penalty.

Non-Cash Rollovers

Non-cash assets, such as stocks or mutual funds, can be rolled over but are subject to the same tax rules as cash. Those assets are moved at "fair market value" and are taxed as ordinary income even if some income in the traditional plan was capital gains. A distribution from a traditional IRA before age 59 1/2 is subject to a 10 percent penalty, but this is waived for conversion to a Roth IRA.

Plan Types

Funds in any employer-sponsored plan, including Simple Employee Pension and Savings Incentive Plan for Employee IRAs can be rolled into a traditional IRA without any tax or penalty, except that SIMPLE funds can't be moved until two years after you first participated. All those funds also can be rolled into Roth IRAs, but all the money moved must be included in taxable income.

About the Author

Bob Haring has been a news writer and editor for more than 50 years, mostly with the Associated Press and then as executive editor of the Tulsa, Okla. "World." Since retiring he has written freelance stories and a weekly computer security column. Haring holds a Bachelor of Journalism from the University of Missouri.

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