If you participate in an employer’s qualified retirement plan, you might wish to roll over your plan balance to an individual retirement account, either while still employed or after you leave the job. You can indeed roll a qualified employer plan, including the 401(a) and 403(b) varieties, into your IRA and avoid taxes in the process, as long as you observe the Internal Revenue Service rules.
Eligible Rollover Distributions
Qualified employer plans are ones that meet IRS requirements and thus receive tax benefits. Qualified plans can be pensions, profit-sharing arrangements, stock bonus plans, annuities and deferred compensation plans. You can make a tax-free rollover into your IRA, but certain exceptions apply, including required minimum distributions, substantially equal period payments, hardship distributions and amounts distributed to correct excess distributions or that represent loans from your plan. Dividends from your employer-issued securities and life insurance premiums are also ineligible for tax-free rollover.
Before proceeding with a rollover from an employer plan, your plan administrator must make a series of disclosures so that you are aware of your rights and responsibilities. The IRS requires your administrator to tell you of your right to a tax-free rollover to an IRA and the difference in the rules between the old plan and the IRA. The administrator will explain the withholding rules: if you withdraw funds and roll them into your IRA within 60 days, the rollover is tax-free but you pay a 20 percent withholding that you can subsequently recover. You can avoid withholdings if you instruct your administrator to transfer the funds directly to your IRA trustee.
You may have paid income taxes on some or all of the balance in your retirement plan. When you roll taxed amounts into your traditional IRA, they form a “cost basis.” Although withdrawals from a traditional IRA count as ordinary taxable income, you don’t pay taxes on your cost basis. You must file IRS Form 8606 when you withdraw from an IRA with a cost basis. The IRS requires you to withdraw your cost basis in a prorated manner -- you can't simply withdraw the cost basis first. If you roll into a Roth IRA, the untaxed balance is subject to taxation at your marginal rate in the year of the distribution.
You can use an IRA as a conduit to park the funds from an employer plan and then roll them into a new employer’s qualified plan. However, if you contribute to your conduit IRA and roll these contributions into your new employer plan, you might lose tax benefits. You can directly roll over property, such as stocks and bonds, from your employer plan to your IRA. You may also sell the property and contribute the proceeds to an IRA, as long as you observe the 60-day deadline. In this situation, you don't recognize any capital gains or losses. You can't keep the property and substitute your own money for sale proceeds.
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