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October 2016 Tip of the Month

Roll Over Beethoven

If you leave your job, you will probably be given the options of rolling over your money from the company pension plan into an IRA, leaving it invested in the former employer plan, or transferring it into another employer plan.  We at Abo and Company typically see the following reasons many of our individual and even business clients give us for keeping the funds in the employer plan which might include:

  • Insecurity about making investment decisions on your own; 
  • Desire to retain ability to borrow from the plan (not permitted for IRAs); 
  • Better legal protection against creditors under Federal law than is provided under state law for IRAs;
  • When applicable, desire to preserve 5 or 10 year income averaging in conjunction with a lump-sum pension payout, and  
  • Possibility of being able to defer distributions from the account beyond age 70 ½ if you are still working.

On the other hand, if you decide to roll the funds over into an IRA, you will have better control over the money because you'll be making the investment decisions.  Since tax deferral with IRAs can usually be stretched out further than with a company benefit plan, you will probably end up with a larger pre-tax nest egg.  If you decide that you want to transfer the money into a new plan, it could be done directly from the old employer plan if the new plan accepts direct rollovers.  Alternatively, you may be able to convert the old plan assets to cash and then make the transfer or you might be able to roll over the funds into a conduit IRA temporarily, until you have a new job, and then make a second rollover into the new employer plan.  As you can see, you might be faced with an overwhelming number of options and consequences.  These can usually be resolved after a review and analysis of objectives and available options with a professional financial and tax advisor. 

It wouldn't be the first time, however, we at Abo and Company were told AFTER clients found it necessary to take out money early from their rollover IRA (or even their retirement plan). Alas, doing so can trigger an additional tax on top of the income tax you may have to pay. Here are a few key points to know about taking an early distribution:

1.

Early Withdrawals.  An early withdrawal normally means taking the money out of your IRA or other retirement plan before you reach age 59½.

2.

Additional Tax.  If you take an early withdrawal during 2016, we will need to report it to the IRS when we prepare your return and you may have to pay income tax on the amount you took out. If it was an early withdrawal, you may have to pay an additional 10 percent tax.

3.

Nontaxable Withdrawals.  The additional 10 percent tax does not apply to nontaxable withdrawals. They include withdrawals of your cost to participate in the plan. Your cost includes contributions that you paid tax on before you put them into the plan.

As we alluded to above, a rollover is a type of nontaxable withdrawal. A rollover occurs when you take cash or other assets from one plan and contribute the amount to another plan. You normally have 60 days to complete a rollover to make it tax-free.

4.

Check Exceptions.  There are many exceptions to the additional 10 percent tax. Some of the rules for retirement plans are different from the rules for IRAs.

5.

Check Withholding.  If a distribution from an IRA or a retirement plan is paid directly to you, as we mentioned above, you can deposit all or a portion of it in an IRA or a retirement plan within 60 days. Taxes will be withheld from a distribution from a retirement plan, so you'll have to use other funds to roll over the full amount of the distribution.

6.

Be Careful of the One-Rollover-per-Year-Rule. You generally cannot make more than one rollover from the same IRA within a 1-year period. You also cannot make a rollover during this 1-year period from the IRA to which the distribution was rolled over. As of last year, you no longer can make more than one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own. However, the one-per year limit does not apply to rollovers from traditional IRAs to Roth IRAs (conversions); trustee-to-trustee transfers to another IRA; IRA-to-plan rollovers; plan-to-IRA rollovers; and plan-to-plan rollovers. Now if you make more than one, you must include in gross income any previously untaxed amounts distributed from an IRA if you made an IRA-to-IRA rollover (other than a rollover from a traditional IRA to a Roth IRA) in the preceding 12 months, and you may be subject to the 10% early withdrawal tax on the amount you include in gross income.