Traps When Moving IRA and Retirement Plan Assets

It pays to be careful when moving money from one traditional individual retirement account (IRA) to another or from an employer’s retirement plan to an IRA. Unless you follow certain guidelines, you may find yourself paying taxes on what could have been a tax-free transaction.

60-day time limit.

Tax Traps

You can withdraw all or part of the assets from your traditional IRA and reinvest them in the same or another traditional IRA. But you don’t have an unlimited time to complete the rollover. For the transaction to be tax free, you must reinvest within 60 days. The same 60-day time limit applies to rolling over an eligible distribution you receive from your employer’s plan (but see 20% withholding below for another potential trap).

Non-cash rollovers.

When you withdraw securities or other non-cash property from your traditional IRA, your rollover to another traditional IRA will be tax free only if you contribute the same property you withdrew. With a distribution of non-cash property from an employer’s plan, you also have the option of selling the property and contributing the sale proceeds to a traditional IRA. However, you can’t keep the property and contribute cash in its place.

Rolling over a plan distribution of appreciated employer securities into an IRA isn’t necessarily the most tax-wise alternative. Taking the securities is sometimes a better option if you qualify for special tax treatment.

Waiting period. After you’ve made a tax-free IRA rollover, you generally must wait at least a year to do another rollover from that IRA or the IRA into which you rolled over your funds. The one-year period begins on the date you receive the IRA distribution. If you want to move your money to another IRA before the year is up, you can have your IRA trustee transfer funds directly to another IRA trustee. The once-a-year limit doesn’t apply to rollovers of eligible distributions from an employer’s plan.

20 % withholding.

If you’re rolling over a distribution from an employer’s plan into another employer’s plan or an IRA, it’s usually best to arrange for a direct rollover. With a direct rollover, your plan simply pays the distribution directly to the other plan or your traditional IRA. If the plan pays the distribution directly to you, it’s required to withhold 20% for federal income taxes. You’ll have to replace the 20% withheld with funds from another source if you want to roll over the entire distribution within 60 days. A direct rollover avoids the withholding trap.

Looking Ahead

What’s in store for taxpayers in the not-too-distant future? Although it’s anyone’s guess what Congress will do, significant tax law changes are on the horizon. Absent new legislation to the contrary, in 2013:

  • Individual income-tax rates will increase.
  • Rates on long-term capital gains and dividends will increase.
  • Higher income taxpayers will pay additional Medicare taxes on earned income (0.9%) and a surtax on investment income (3.8%).
  • The top federal estate-tax rate will increase from 35% to 55%, and more estates may be taxable since the basic exclusion amount will decrease from $5.12 million to $1 million.

In view of these and other potential changes, savvy tax planning is more important than ever.