How to Avoid Common Rollover IRA Mistakes

The question of a rollover IRA usually comes up when you switch jobs.

You might decide to take your 401(k) with you, or you could choose to roll over your IRA into a Roth.

When I wanted to do this, my financial advisor cautioned me about the various traps out there.

Let me tell you about the most prominent ones:

The 20-percent-withholding trap - and how to avoid it

When you quit one job for another, this is a good time to rollover your 401(k) into an IRA. This way, you can get a variety of investment options, instead of just keeping your old 401(k) or rolling it over to your new employer. This depends on your employer, though.

You can ask your employer to let you have the balance in your account, but this means you have to give up 20 percent of this amount in taxes. In addition to the 20 percent, if you are under the age of 59 1/2, you will also end up paying a penalty of ten percent. You are unlikely to get this back until you pay taxes.

So, is there a way you can avoid this? You can opt for a direct rollover. Have your retirement plan distribution check made out in the name of your IRA custodian where you would like to receive those funds. The bank or broker will tell you how to do this. Then, notify your employer about this direct rollover. After you get the check, you deposit it into the rollover IRA.

What is the 60-day rule?

There is a 60-day rule for rollovers, which means that you have to deposit the check within 60 days. There are exceptions, of course, that you need to become familiar with.

A one-year waiting rule?

There is also a one-year waiting rule. It states that, after you withdraw from your IRA and rollover a portion of that amount, you are not allowed to make another rollover from the same IRA to another IRA for one year. So, let's say you have two IRAs, A and B. If you make a tax-free rollover from A to a new IRA, C, you cannot make another tax-free rollover from A or C to another IRA for one year. But, this rule does not apply to B. Here again, this limit does not apply to eligible rollover distributions from an employer plan or a rollover from a traditional IRA to a Roth IRA.

Cash to cash, or shares to shares

There's another issue here. If you take cash from your retirement plan account, you must roll over cash into your IRA. If not, you will have to pay taxes on the withdrawal. For example, you cannot withdraw cash, buy stock, and then try to roll the stock over. By the same token, if you withdraw stocks from an IRA account, you must rollover that stock.

Can I use an IRA rollover for short-term borrowing?

If you have an emergency for which you need the cash NOW, you can borrow from your IRA account with zero documentation and zero interest. All you need to do is withdraw the money, and put it back within 60 days. This is a tax-free IRA rollover.

What about eligibility for a rollover IRA?

It's okay to make a tax-free rollover from your IRA anytime. But, if you are over the age of 70 1/2, you cannot rollover your annual required minimum distribution. This procedure is viewed as an excess contribution, which has its own set of rules.

When should I avoid a rollover IRA?

If your aim is just to move your IRA from one company to another and you do not plan to use the money, opt for a transfer rather than a rollover IRA. You can make transfers as many times as you want without worrying about the 60-day rule or the one-year rule.

In any case, make sure you find out the exact details with your existing as well as your prospective employer, in addition to consulting your IRA custodian, when applicable.

I use Zecco for all my rollover IRA and retirement invest planning.


Return from Rollover IRA to Individual Retirement Account


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