Can You Rollover an IRA Without Paying Taxes?
Once you leave a workplace retirement account, transferring the money over into an individual retirement account (IRA) could help avoid tax penalties if done correctly.
Errors can be costly. Failing to follow the rules could cost you dearly in terms of taxes owed or penalties totalling 10% for noncompliance.
What is a rollover?
Rollovers involve moving assets from one retirement account to another while maintaining tax-deferred status of both. It can be beneficial when changing employers, switching jobs or retiring; in such instances, the IRS lays out detailed rules regarding rollovers; for instance, you have 60 days from withdrawing money to transfer it or pay taxes and penalties on it as it will become subject to tax and penalty liability.
As with any move, whether direct or indirect is dependent on many factors – your current financial state and anticipated tax bracket are two. A Roth IRA might be best for those expecting to fall into higher tax brackets at withdrawal; otherwise a traditional IRA might offer better protection and help to minimize tax bills now.
Direct rollover is the most frequently employed form of rollover. Under this plan, an administrator of your retirement plan sends a check directly to your new account provider; then this provider deposits it directly into it for deposit into your new account. Neither you nor any funds withheld from distributions prepay your tax liability, since you are ultimately responsible for depositing them into an IRA in order to complete this rollover process.
An indirect rollover does not count against the IRS’ limit on how many IRA-to-IRA rollovers you can do per year, however other types of IRA accounts (SEP and SIMPLE IRAs) count against this cap. Therefore, when contemplating a rollover it is crucial that you consult with a tax professional – they will assist with deciding between direct or indirect rollover as the most suitable method of moving funds and ensure compliance with IRS rules.
Direct rollover is the fastest and easiest way to transfer retirement funds between accounts. All it takes to initiate the process is contacting your old employer-sponsored plan administrator and asking that it send your total account balance directly to your new IRA provider – they should give instructions as to what information should be included on this check – including where and when it needs to be sent for mailing purposes. Alternatively, some IRA providers allow wire payments instead.
Indirect rollovers can be more complex, as you must set aside funds in order to cover the 20% that is withheld for taxes in your distribution and deposit it all within your IRA within the 60-day Indirect Rollover window.
If your Indirect Rollover application is not completed within the allotted timeframe, the IRS will consider your distribution to be an ordinary withdrawal and assess income taxes as well as an early withdrawal penalty of 10% if you are under age 59 1/2.
When filing your taxes, you’ll need to report the transfer on Line 5b of Form 1040. In order to show proof that money was transferred directly into an IRA from its original transaction receipts. If it’s a direct rollover transaction, mark both Box 2a (Taxable Amount) and Box 7 (Distribution Code) with “G”. Doing this will allow any withheld tax funds from that original transaction to be credited back into your IRA at tax time; for indirect rollovers it might be best consult a tax professional on how to complete such an indirect rollover transaction successfully.