Understanding IRA Roll Overs

Roll-over IRAs are designed to receive contributions from existing retirement plans such as defined contribution (i.e. 401K, 403b, 457 plans) or defined benefit plans such as pensions. Choosing how to deal with these funds often comes at exactly the wrong time-involuntary separation. Here is the correct way to transfer funds so that every dime of your hard-earned cash stays in your hands, not Uncle Sam's.

When you retire, quit, are laid-off or terminated, you are faced with three choices: Leave your money with your employer, have a check issued in your name, or roll funds over to a new IRA with an investment company.

For employees under retirement age, the incorrect choice can have serious consequences. The first option, leaving the money with your employer is the easiest. Unfortunately, if the amount involved is very small, the employer may not want it. Even when the funds are ample, an employer's plan may be burdened with excessive costs and limited choices, so you may wish to move your funds elsewhere.

The second choice, a check in hand, is inviting, but treacherous. During the Reagan Administration, a new law was passed. Formerly, departing employees were handed a check for the full amount of their retirement funds. Now, the employer is required to take 20% off the top and send it to the government. You however, must deposit, not 80%, but 100% of the funds in a roll-over IRA or in your new employer's plan within 60 days or face taxes at your highest marginal rate and a 10% penalty.

If you are under retirement age, your best option is a roll-over IRA funded by direct transfer of your retirement assets to the investment company or bank of your choice. This can be accomplished by two methods. First, you may contact the company where you wish your money to be sent and have them make arrangements to transfer the funds.

They will send you an application for a new account which you will fill out and return. Once the new account is established, you may direct your former employer where to send the funds or authorize the investment company or bank designated to receive the funds to call on your behalf.

Having a check made payable to the investment company and sent to you is another option. If you choose to receive a check, it will not be made payable to you. Let us assume your name is Joe Blow and you want to establish an IRA at Anybank, USA. The correct way to title the check is: "Anybank, USA for benefit of Joe Blow, IRA." This renders the check uncashable by you and makes it clear to the IRS that the funds were sent straight to Anybank.

By having transfer handled directly between your employer and the new custodian of your IRA or by receiving a check that you cannot cash, you will ensure that 100% of your funds are transferred to your new account.

You will avoid unnecessary penalties and taxes, and if you do need to access a small amount of money during a period of unemployment, you may do so by withdrawing the necessary amount only rather than exposing the entire balance to taxes and penalties. You may be able to avoid penalties even on that smaller amount if you redeposit it into another IRA within 60 days. The law allows this once a year.

Sources:

http://www.irs.gov/publications/p590/ch01.html#en_US_publink1000230568