Moving Retirement Funds: Transfers and Rollovers

Take-Away: When moving retirement funds between IRAs or from qualified plans to IRAs, it is best, and safest, to move funds in a direct transfer or direct rollover, and skip the 60-day rollover option.

Background: Basically, there are three different methods used to move retirement dollars. Two are pretty straightforward. The third is fraught with risk and penalties. Unfortunately, retirement account owners tends to mix up these methods, or assume that they are all the same,  but the rules are different for each.

1. Direct Transfer: A direct transfer is the safest, and thus the most often recommended, approach to move retirement funds. This is usually called a trustee-to-trustee, or custodian-to-custodian transfer. The retirement funds go directly from one IRA custodian to another IRA custodian. It is also possible to use an FBO check, where the transferring  ‘old’ custodian makes the check out to the second ‘new’ custodian ‘for the benefit of…’ with that check then delivered by the account owner to the ‘new’ custodian. A direct transfer is not reportable to the IRS, which means no Form 1099-R is generated for the transfer. Note, too, that if the account owner is at his/her required beginning date (RBD) and thus he/she must take a required minimum distribution (RMD), their entire retirement account, including the RMD amount, can be directly transferred to the new custodian. Restated, there is no need to take the RMD before the direct transfer is implemented (but the account owner’s RMD must still be taken by the normal deadline, albeit from the new IRA custodian.) Nor is there any mandatory withholding of 20% of taxes with a custodian-to-custodian transfer of retirement funds.

   Example: Alice maintains an IRA with BigBank. Alice also has an account with Greenleaf Trust. Alice wants to consolidate her IRAs at Greenleaf Trust to simplify her records and keep track of her RMD obligations each year. Alice requests a direct transfer of her IRA from BigBank to Greenleaf Trust. BigBank can issue a check that represents Alice’s  BigBank IRA made payable to “Greenleaf Trust f/b/o Alice.” This check which is handed to Alice will qualify as a direct transfer from BigBank to Greenleaf Trust as soon as Alice delivers the check to Greenleaf Trust.

2. Direct Rollover: If retirement funds move from a qualified plan like a 401(k) account to an IRA, the best option is the direct rollover. Looking at this from another perspective, a direct transfer is not available when retirement funds are moved from a qualified retirement account, like a 401(k) plan, to an IRA. That said, a direct rollover is pretty much like a direct transfer, but with a couple of differences. The first difference is that a direct rollover is a reportable event to the IRS, which will show on a Form 1099-R the distribution. Once the retirement funds are received by the IRA custodian, it will in turn generate a Form 5498 that confirms the rollover. These two forms eliminate any possible income taxes that would otherwise be due on a ‘distribution.’. A second  difference is that if the plan participant is age 72 or older, then their required minimum distribution (RMD) must be taken and paid to the participant before the balance of their qualified plan account balance can be directly rolled over to the IRA. Like the direct transfer  a direct rollover  avoids the mandatory 20% federal tax withholding, which would otherwise be the case if the retirement funds were  paid directly to the plan participant.
3. 60-day Rollover: If an IRA owner or qualified plan participant takes a distribution that is directly paid to them, he/she has 60 days in which to redeposit all or part of those dollars into the same or a similar account. These funds can move from a qualified plan to an IRA, or from an IRA to another IRA, via a 60-day rollover. However, a 60-day rollover is seldom (if ever) recommended due to the risks that are  associated with ‘missing’ the 60-day deadline. A missed deadline means the entire amount that was not redeposited within the 60 days becomes immediately taxed, and probably also subject to the additional 10% penalty for taking a taxable distribution prior to age 59 ½. A 60-day rollover also means that it will be subject to the mandatory 20% withholding, and if the account owner is age 72 or older, then cannot be part of the funds that are to be redeposited within the 60-day deadline.  The withheld taxes must also be redeposited within the 60 days if the intent is to avoid all taxes. Add to these rules the fact that there can only be one rollover every 365 days, and it is easy to see how costly mistakes are made when engaging in a 60-day rollover. And, just to make it even a bit more confusing, a non-spouse beneficiary cannot engage in a 60-day rollover with an inherited retirement account (IRA or qualified plan); inherited retirement accounts can only be moved by either a direct transfer or a direct rollover.

Conclusion: It is easy to see how account owners can get confused when they inter-change the three different types of methods to ‘move’ retirement funds. It is important to keep the methods straight since they will impact how taxes are withheld, reporting obligations, and the tax and penalty risks associated with missing the 60-day rollover deadline.