The Basics of Rollover IRAs
When you retire, you’ll be eligible to receive the money you’ve accumulated in your employer-provided retirement plan. The money might be paid to you in a single lump sum or other eligible rollover distribution that can be rolled over into an individual retirement account (IRA).
What is a Rollover IRA?
A rollover IRA is a traditional IRA that accepts rollovers from another IRA or employer qualified plan. There is no limit on the amount you are allowed to rollover to the traditional IRA. For 2009, the maximum regular contribution that can be made to a traditional IRA is $5,000, plus an additional catch-up contribution of $1,000 if you are at least age 50.
Taxes and Rollover IRAs
Tax-deferral is probably the biggest advantage of a rollover IRA. When you receive an eligible rollover distribution from your employers retirement plan, you have a choice. You can either pay tax immediately on the distribution or you can defer paying tax by directly rolling the distribution over into an IRA (or another eligible plan).
If you choose the IRA rollover, you can postpone paying tax until distributions begin. And you don’t have to start receiving payments from your IRA until April 1 of the year after you reach age 701/2*. Just remember, once you begin taking withdrawals from your IRA, tax will eventually be due.
The IRS requires you to complete your rollover within 60 days after receiving the distribution. Generally, however, its more advantageous to have the money transferred directly from your former employers plan to an IRA. Heres why. There is a 20% withholding requirement on all eligible rollover distributions from qualified retirement plans that are not directly transferred to IRAs or other eligible retirement plans. So, if you actually take possession of the distribution, you will see 20% of it withheld for federal tax purposes.
If you then decide within 60 days of receiving your distribution that you want to roll over the full amount, you must supply the withheld 20% from other sources to put in your rollover IRA. When you file your tax return, you may receive a refund of the withheld tax. If you don’t make up the difference and simply roll over the 80% you have in hand, the withheld 20% will then be considered a taxable distribution. That means you’ll have to pay taxes on the 20%. By having the distribution transferred directly to your IRA, you can avoid this 20% withholding altogether. And 100% of the distribution will continue to grow on a tax-deferred basis.
* The Worker, Retiree and Employer Recovery Act waives the minimum distribution requirement for calendar year 2009 only. As a result, no required minimum distributions need to be taken for 2009. Additionally, if you turn 701/2 in 2009, you will not have to take your first distribution by April 1, 2010. The deadline for your first required minimum distribution (for 2010) will be December 31, 2010.