Rollovers keep IRAs relevant by preserving tax shelters
Most Americans don’t contribute new money to Individual Retirement Accounts. Even fewer take advantage of catch-up contributions. But rollovers? They remain a vibrant area of IRA activity, with continuing growth likely ahead as more Baby Boomers retire and younger workers switch jobs.
Rollovers don’t receive as much attention as IRA contributions or distributions, partly because they’re relatively simple transactions. But there are a few tax pitfalls to beware, and the often large dollar size of rollovers makes it incumbent on investors to get it right.
Rollovers are movements of money from one type of tax-sheltered account into another, especially switches from workplace 401(k)-style plans into traditional IRAs but also changes from one IRA to another.
Rollovers are largely responsible for the growth of IRA investment dollars, according to a study released this year by the Investment Company Institute. The mutual fund trade organization estimated Americans hold $7.5 trillion in IRAs overall, representing 31% of all U.S. retirement assets. That’s up from a 19% share two decades earlier.
About half of all IRA holders said they never contributed money into their accounts, meaning their entire balances came from rollovers, the report noted. Of all IRA-owning households, roughly three in five had at least some money from rollovers.
Only 11% of U.S. households contributed money to IRAs in the most recent year examined.
Rollovers become important when people change jobs or retire. Some employers don’t let former workers keep assets in their 401(k) plans, and new em- ployers don’t always accept dollars from other plans. In such cases, it makes sense to switch the money into a rollover IRA.
“If you receive a payout from your company because you have retired, resigned, were laid off, downsized or whatever, rolling over to an Individual Retirement Account would definitely be to your advantage in most cases,” wrote Don and David Wilkinson, authors of a new book, Rollover.
When money moves from a 401(k)-style plan into a rollover IRA, investors generally preserve their tax-sheltered growth, with no taxes due on these transactions. But this point deserves clarification. When you move money into IRAs, there are two basic ways to go. One is a transfer and involves a direct shift of money from one custodian to another.
“In a transfer, the funds are directly payable from your current IRA custodian to your new IRA custodian,” noted Sarah Brenner, an IRA analyst for the Slott Report. You don’t directly take possession of any funds in the process, but you may conduct multiple transfers in the same year, if you want.
With a rollover, by contrast, you receive a distribution check, with the idea of reinvesting the money with another custodial firm. Because you take possession of the funds for a short period, you can use the money as a shortterm loan, provided you repay it in a timely manner by reinvesting in a new IRA.
One problem with this type of rollover is that investors now are allowed just one such transaction per 365-day period. Another danger is that required minimum distributions from traditional IRAs can’t be rolled over into a new IRA. RMDs apply to people who have reached age 701⁄
But most important, you must complete your rollover by reinvesting the funds within the 60day window. If you don’t, the money that isn’t reinvested is treated as a permanent distribution, triggering ordinary taxes and, possibly, a 10% penalty if you’re under age 591⁄
“If you receive a payout from your company because you have retired, resigned, were laid off, downsized or whatever, rolling over to an Individual Retirement Account would definitely be to your advantage in most cases.”
Don and David Wilkinson, authors of a new book, Rollover
Reach Wiles at russ.wiles@arizonarepublic.com or 602-444-8616.