How to Roll Over Traditional IRA to 401(k) Without Tax Penalties
When you leave a company, the safest option for your 401(k) is to roll it into a traditional IRA. This allows your retirement fund to continue growing, tax-deferred, until you're ready to retire. But what happens if you accept a new job that offers a great plan with matching funds? Can you roll your traditional IRA into the new employer plan – something called a reverse rollover? The answer is yes, in many cases you can. As long as the 401(k) accepts incoming rollovers, you can roll your IRA funds into it. But it's worth understanding the potential pitfalls before you pull the trigger.
What Is a Reverse Rollover?
Most rollovers move in one direction – from an employer plan like a 401(k) or 403(b) to an Individual Retirement Account. Rollovers typically happen when you leave an employer and are no longer eligible to participate in the workplace plan. Instead of leaving the cash sitting in the old account, you can move it to an IRA that you control.
Moving money the other way, from an IRA into a 401(k), is known as a reverse rollover. A rollover is tax terminology for when you move the balance from one retirement plan into another plan. As long as you complete the rollover within 60 days, it's penalty-free and non-taxable. It's also easy to do – as long as you follow the rules.
How to Do an IRA Rollover to a 401(k) Without Tax Penalties
First, you must check your eligibility. You can only roll an IRA into a 401(k) if the provider is willing and able to accept the deposit. Some plans will, some plans won't.
Assuming you're permitted to do a reverse rollover, the next step is to request a distribution from your IRA. There'll be some paperwork to fill out that you can request from the plan provider. Be sure to select "direct rollover" as the reason for the distribution, and the IRA administrator will send an electronic transfer or a check directly to the 401(k) trustee.
The key point here is that you will not receive the money personally, which means there's no distribution for tax purposes. You won't have to pay income taxes on the rollover and the IRS will not levy a 10 percent early withdrawal penalty on the account balance. The transaction is tax-neutral and penalty-free.
Potential Tax Pitfalls With an Indirect Rollover
While a "direct" rollover is free from tax penalties, be careful if the IRA administrator sends you a personal check for the account balance. This will trigger an "indirect rollover," which basically is a short-term loan from the account. You now have 60 days to deposit the money into your 401(k); otherwise, the IRS will treat the rollover as a distribution and you'll be forced to pay taxes and a 10 percent penalty on the money if you're aged under 59 1/2. Only, there's a catch.
Since taxes are due on IRA distributions, the account administrator is legally obligated to withhold 20 percent of your account balance for federal tax withholding. So, if you request a $20,000 distribution, you will only receive $16,000. The remaining $4,000 is sent to the IRS to cover the taxes. But you must deposit the full $20,000 into your 401(k) to avoid tax penalties. If the amount of the distribution from your IRA and the amount you deposit into your 401(k) don't match, you'll owe taxes and a 10 percent penalty on the difference.
Really watch the 60-day deadline too – it's not the date you mail the check to your employer that stops the clock, it's the date the money is deposited. The safest bet is to transfer the IRA to the 401(k) directly and avoid these potential pitfalls.
Report the Rollover on Your Tax Return
For both direct and indirect rollovers, you must report the transaction when you file your annual tax return. Your IRA brokerage will send you form 1099-R, showing the amount you withdrew from your IRA. Report this number on your 1040 tax return on the line labeled "IRA Distributions." The "Taxable Amount" you record should be zero. Select "rollover" as the reason why.
Why Transfer an IRA to a 401(k)?
A reverse rollover will not be right for everyone. It depends on the terms of the 401(k) and whether you'll be better off putting as much money as possible into the workplace plan or keeping the funds split between a 401(k) and an IRA. There are several things you might consider:
- Streamlining your accounts: Some people like having all their retirement money in one place because it's much easier to monitor and organize that way. By consolidating your IRA funds into your 401(k), you get to keep an eye on your retirement savings in one statement.
- Taking early or late retirement: You can't take money out of an IRA before age 59 1/2 without paying a 10 percent penalty on top of any taxes you'd normally pay, so it can be expensive to access your money. Some employer plans, on the other hand, let you take penalty-free withdrawals at age 55, instead of having to wait until the IRS-mandated retirement age of 59 1/2. So if you're thinking about early retirement, it may be sensible to move your money to a 401(k). Bear in mind, too, that if your money is held in a traditional IRA, you have to start taking Required Minimum Distributions from age 70 1/2 no matter what. You don't take RMDs from a 401(k) until you actually retire, which is a boon for your finances if you wish to retire later.
- Reduced contribution limits: You can only put so much into a retirement plan each year, but separate contribution limits apply to IRAs and 401(k)s. In 2018, you can contribute up to $18,500 annually to a 401(k) and an additional $5,500 to an IRA – those figures rise to $24,500 and $6,500 if you're aged over 50. In 2019, the contribution limit is rising to $19,000 ($25,000 for over 50s) for a 401(k) and $6,000 ($7,000) for an IRA. Keep both accounts open, and you can contribute more tax-free money towards your retirement.
- Limited investment choices: With an employer plan, you're limited to its menu of investment choices. With an IRA, your choices are virtually limitless since you can invest in just about anything except for collectibles, derivatives, personal real estate, coins and life insurance. Less choice means there's less opportunity to create a well-diversified portfolio with a 401(k).
- Fewer early withdrawal exceptions: IRAs tend to be more lenient that 401(k)s when it comes to withdrawing the cash early, before the age of 59 1/2. Generally, you'll avoid the 10 percent penalty if you withdraw money from an IRA to pay for medical bills, health insurance premiums if you're unemployed, higher education costs or the down payment on your first home (up to $10,000 withdrawal permitted for a down payment). In fact, you can withdraw at any time and for any reason from an IRA – as long as you're prepared to pay taxes and the 10 percent penalty. With a 401(k), you must abide by the rules of the plan.
- Fees may be higher: With a 401(k), you're stuck with its fee schedule. High fees can erode your retirement savings over time. With an IRA, on the other hand, you have the ability to shop around for the plan with the lowest charges. If it's flexibility you're after, then keeping your IRA makes sense.
- Internal Revenue Service: IRA Contribution Limits
- Society for Human Resource Management: For 2018, 401(k) Contribution Limit for Employees Rises to $18,500
- Internal Revenue Service: Rollover Chart
- Internal Revenue Service: Rollovers from Retirement Plans
- Internal Revenue Service: Rollovers of Retirement Plan and IRA Distributions
- IRA Investment Choices - Fidelity
Jayne Thompson earned an LLB in Law and Business Administration from the University of Birmingham and an LLM in International Law from the University of East London. She practiced in various “big law” firms before launching a career as a commercial writer. Her work has appeared on numerous financial blogs including Wealth Soup and Synchrony. Find her at www.whiterosecopywriting.com.