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All You Need To Know About IRA Rollovers

According to the Bureau of Labor Statistics, the average person stays in a job for just over 4 years. Workers in the 25-34 year old age bracket stay in a job for just under 3 years.

If you’re a job hopper, or even someone who’s only left a job once or twice, you need to know what to do with the workplace retirement plan savings you’ve accumulated during your tenure. Most employers will force you to do something with it when you leave. Do the wrong thing and it could cost you hundreds or even thousands of dollars in taxes and penalties.

While the IRA rollover is the simplest solution to keep your retirement nest egg growing tax-deferred, the notion of completing one can be intimidating. Here’s what you should know if you’re ever faced with the prospect of needing to complete an IRA rollover.

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Why Rollover Your Retirement Plan Balances?

When you invest in a workplace retirement plan, such as a traditional 401(k), your savings grow tax-deferred until they’re withdrawn at retirement (in a Roth 401(k), they grow tax-free). That’s an especially appealing feature since tax-advantaged accounts are able to grow at a faster rate over time. Since your employer will most likely require you to take your plan with you when you leave, rolling it over into an IRA allows you to continue taking advantage of tax-deferred growth. If you fail to rollover your plan balance into an IRA within a reasonable amount of time, that money gets taxed immediately and becomes subject to a 10% early withdrawal penalty (assuming you’re under age 59 ½). Completing a rollover, quite simply, let’s you keep more of your own money and avoids costly IRS penalties.

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The Primary IRA Rollover Rules

Individuals have 60 calendar days from the time a retirement plan distribution is received to roll the money over into an IRA. The date that you quit your job has no impact on when the 60-day window begins.

There are two primary ways of completing a rollover. You can initiate a direct transfer of funds where your employer and the company receiving the distribution work together to move your plan balances. This method is particularly advantageous because it doesn’t require you to take possession of the funds once you complete the initial transfer paperwork. The other method is the 60-day rollover, where your employer cuts a check payable to you, and it’s your responsibility to get the funds to their destination. This method can be tricky, because when issuing a check directly to you, the employer is required to withhold 20% of the balance, which goes to the IRS as a pre-payment of taxes. You would need to come up with that 20% out of personal savings to complete the full rollover. For example, if you have $10,000 saved in a 401(k) and wish to complete a rollover where the check is made out to you, your employer will issue you a check for $8,000 and forward the remaining $2,000 to the IRS. You need to come up with the additional $2,000 to go along with the $8,000 check to complete the rollover. If you fail to do this, the $2,000 shortfall would be considered an early distribution subject to taxes and penalties.

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Procedure to Rollover Current Plans

The best place to start is reaching out to your employer’s HR area. Most companies have paperwork that is needed to direct where you want your plan balance to go, whether that’s to you or directly to the new custodian. If the check gets made out to the new custodian, no withholding will be taken from the distribution. If the check gets made out to you, the 20% withholding applies. In some cases, employers will forward the check directly to the company you’re rolling over to. Check with your employer to learn about all your options.

Eligible Plans For Rolling Over Into An IRA

Virtually any pre-tax qualified retirement plan, such as a traditional 401(k), SEP-IRA, 403(b), 457(b) and SIMPLE IRA, is eligible to be rolled over into a traditional IRA. After-tax plans, such as the Roth 401(k), must be rolled over into a Roth IRA. Transfers from a Roth account back to a traditional account are not allowed. Check out this handy chart from the IRS to see which types of plans can be rolled into others.

Learn about the different types of IRAs here.

What about Rollover Limits?

There is no limit to how much can be rolled over from a workplace retirement plan into an IRA. This shouldn’t be confused with the annual IRA contribution limits for new investments, which for 2017 are set at $5,500, and $6,500 for people age 50 and above.

Watch Out For These Pitfalls

The biggest tipping point for savers is the 60-day window to rollover. If you miss completing the rollover within this time frame, your savings are subject to taxes and penalties (except under extenuating circumstances). The other major pitfall is failing to come up with the cash necessary to rollover the 20% withholding on distributions, an error that can be very costly if made. It’s also worth noting that required minimum distributions are not eligible to be rolled over.

The Bottom Line

Any financial transaction that involves paperwork can be inherently confusing, but the IRA rollover is worth it. Failing to rollover a retirement plan when you leave a job can put a huge dent in your retirement savings, while hitting your pocketbook immediately with taxes and penalties. Rolling over your retirement plan keeps your money growing tax-deferred, and keeps you on pace for retirement.

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