Let’s face it… for many planning for a comfortable and secure retirement can feel overwhelming at times. But then again, anything worth doing has never been easy, right? There are literally hundreds of complex regulations governing your retirement accounts alone.
It breaks my heart whenever I meet people who believe they did everything right, only to find themselves having misunderstood or been unaware of various regulations. It happens too often. And these mistakes expose investors to taxes and penalties that could have easily been avoided, or shorted themselves of tens of thousands of dollars in retirement income.
What I want to talk about here are two of the more common mistakes I have seen investors make in rolling over IRAs or other retirement plans to a new IRA.
What is a rollover? It’s when you close one retirement plan and transfer the funds to an IRA. Maybe you’re switching careers and you want to rollover the 401(k) plan provided by your old employer. Or maybe you have decided, for example, to move your money from one IRA custodian to a new IRA custodian. There are many reasons for rollovers.
This is how it works…
When you request a rollover, your old plan’s trustee will issue a check for the funds. The check will be made out in either your name or the name of the new plan’s trustee. The first is called an indirect rollover – you accept the funds, and then you personally deposit them into the new plan. The latter is known as a direct or trustee-to-trustee rollover.
Sounds simple, right? Well, it can get a little tricky.
Let’s talk about a couple of the more common rollover mistakes and how to avoid them…
When you do an indirect rollover, the IRS allows you 60 days to transfer the full distribution to an IRA. Maybe you would like to use the distribution as a short-term loan for an emergency, or it could be that you haven’t yet decided who is going to be the custodian of your new IRA. Whatever the case may be, your 60-day rollover has a deadline.
What happens if you miss this deadline? Well, if you’re under the age of 59.5 years, you will be hit with a 10% penalty on the amount not rolled over. You may request a waiver for this penalty, but the IRS imposes several criteria for which you must qualify.
How often does this actually happen? You might be surprised. People make honest mistakes – they lose track of deadlines, overestimate their abilities to repay short-term loans, etc.
You can easily avoid this potential nightmare, of course, with a trustee-to-trustee rollover. This is what I would typically recommend.
A couple of generations ago, it wasn’t uncommon for people to spend their entire careers with a single employer. Times have changed. In fact, FastCompany.com reported that millennials are averaging a 4.4-year tenure per job.
With change occurring this frequently, there is a lot of opportunity here for rollover errors that could cause you to pay unnecessary taxes and penalties.
Here’s the main problem…
When you indirectly rollover a retirement plan to an IRA, the IRS withholds 20%. Yes, you’ll potentially get the money back when you file your taxes for the year, but many aren’t aware that the IRS expects them to rollover the full distribution, including the 20% withheld. So, you will need to obtain those funds from other sources – i.e. personal savings, other investments.
If you are under 59.5 years of age and fail to roll the full amount over to an IRA, you will be hit with that 10% penalty – unless, of course, you file a waiver and are approved.
I’m not saying the rule is fair, but the easiest way to prevent this mistake is again with a direct rollover. That’s when the company plan’s custodian issues a check directly to your IRA’s trustee. The IRS does not withhold from or impose taxes on direct rollovers.
Well, there you have it. These are just a couple of the more common and yet easily avoided rollover mistakes that I tend to see. Before doing a rollover of any kind I encourage you to always consult with a qualified retirement planning professional to help ensure avoiding costly mistakes.