A rollover is a tax-free distribution of cash or other assets from one retirement plan which is then reinvested in another retirement plan. The contribution to the second retirement plan is called a "rollover contribution."
In general, the following types of plans allow rollovers:
A traditional IRA
An employer’s qualified retirement plan for its employees
A 457(b) eligible governmental pan
A Section 403(b) plan
A Roth IRA (very limited - see IRS Publication 590)
A designated Roth Account within a plan (limited - see IRS Publication 590)
When a participant takes a distribution (other than qualified Roth distributions or after-tax distributions), it is not only subject to current income tax, it may be subject to a 10% IRS penalty if the participant is under age 59½. Furthermore, if a participant under age 55 receives a distribution upon leaving employment, the 10% penalty tax may also apply. However, when a participant rolls a distribution over, the income tax is deferred, so the assets can continue to grow tax deferred.
Distributions from a SIMPLE IRA within the first two years of participation will be subject to a 25% additional tax.
All or any part of a retirement account balance can be rolled over, but NOT the following:
(1) A corrective distribution made to correct excess contributions,
(2) A distribution that is a series of substantially equal periodic payments made at least annually based on life expectancy or a period of at least 10 years,
(3) A Required Minimum Distribution (RMD) beginning at age 70½,
(4) A hardship distribution from 401(k) or 403(b) plans,
(5) A plan loan treated as a distribution,
(6) Dividends on employer securities, or
(7) The cost of life insurance coverage.
Note: Participants may be able to roll over the nontaxable part of a distribution to another qualified retirement plan or to a traditional IRA. The participant must make the transfer by a direct plan-to-plan (trustee-to-trustee) rollover to a qualified retirement plan or a section 403(b) plan that separately accounts for the taxable and nontaxable parts of the rollover. Any taxable amount that is not rolled over must be included in income in the year of the distribution.
Participants can roll over a distribution from a designated Roth account to another designated Roth account or to a Roth IRA. If the rollover is to a Roth IRA, the participant can use any rollover method, but if the rollover is to another designated Roth account, it must be made through a trustee-to-trustee transfer. Earnings from a designated Roth account may be rolled over using any rollover method.
A rollover occurs when cash or other assets are withdrawn from one eligible retirement plan and all or part of the withdrawal is contributed to another eligible retirement plan within 60 days. When the rollover distribution is paid to the employee, the employer is required to withhold 20% for income taxes.
The plan administrator (other than an IRA) making the distribution must give the participant a written explanation of the rollover options. Notice 2009-68 contains two sample "Rollover Options" that can be used to satisfy the employer’s written explanation requirements. The first sample is for distributions that are not from Roth accounts and the second is for distributions from Roth accounts.
A direct plan-to-plan (trustee-to-trustee) rollover occurs when the plan administrator transfers the rollover amount directly to a new employer plan or to an IRA. Under this option, the 20% mandatory income tax withholding does not apply.
The employee has 60 days from the date the retirement plan distribution is received to roll over the distribution to another eligible plan. If it is not rolled over within 60 days, the entire distribution could be taxable in the year of the distribution. Since the rollover was not a direct rollover, there has already been mandatory income tax withholding of 20%. If the employee wants to roll the entire distribution to a new employer plan or IRA, funds from other sources will have to be added to make up for the 20% withheld. IRS rules prohibit more than one such rollover per year. Click here to jump to "Indirect IRA Rollovers" for further information.
The retirement plan assets can go to many different types of retirement arrangements. Note that the Appropriations Act of 2016 (Pub. L. 114-113, enacted December 18, 2015) allows participants in qualified plans, Section 403(b) plans and eligible Section 457(b) plans to roll distributions from those plans to SIMPLE retirement accounts. [For more on SIMPLE plans, click here].
There is a 20% mandatory federal income tax withholding requirement. To avoid this 20% withholding, the transaction should be a direct rollover or transfer to a traditional IRA or other eligible retirement plan. But suppose the recipient ignores this advice and receives the distribution in hand—or rather, 80% of the distribution. The withholding tax has already been taken out, but the recipient may still be able to avoid paying the regular income tax currently on the distribution.
This is accomplished by making a tax-deferred rollover to a traditional IRA or other eligible retirement plan. To qualify as a tax-deferred rollover, it must take place within 60 days of the participant's receipt of the distribution. If the recipient antes up the “missing 20%” and rolls over an amount equal to 100% of the taxable portion of the distribution within the 60-day limit, the participant can eventually get a federal income tax refund of the 20% that was withheld, and possibly avoid the 10% premature distribution penalty if he or she is under age 59½.
If the employee fails to put the missing 20% into a traditional IRA, that amount will be treated as a taxable distribution by the IRS. The employee will owe the regular income tax on this 20%, and may be subject to a 10% premature distribution penalty if he or she is under age 59½ (unless an exception applies). Also, the opportunity for tax-deferred earnings on the amount withheld is lost.
The 20% mandatory withholding generally does not apply to substantially equal periodic payments from qualified retirement plans or to required minimum distributions, neither of which are eligible for rollover.
There is no limit on the amount that may be rolled over. After 2001, after-tax employee contributions may be rolled over from a qualified plan to a traditional IRA or to another qualified plan. However, nondeductible employee contributions may not be rolled over. These nondeductible contributions must be retained by the employee, and are received by the employee federal income tax-free. Effective for taxable years beginning after 2006, the entire amount of an eligible rollover distribution (both taxable and nontaxable portions) may be transferred in a direct trustee-to-trustee transfer to a defined benefit plan or to a 403(b) annuity contract, provided such defined benefit plan or 403(b) annuity provides for separate accounting for the transferred amounts (and any earnings on those amounts), including separately accounting for the portion of the distribution which is includible in gross income and the portion not so includible. Employees may also roll over after-tax contributions into an IRA. In this case, the rollover need not be a direct rollover and the IRA owner has the responsibility to keep track of the amount of after-tax contributions.
If the employee wishes to retain the option to roll over the conduit IRA back into another qualified retirement plan, he or she must not make subsequent contributions (e.g., regular annual contributions) to the rollover IRA. If the IRA owner wants to make regular annual IRA contributions, he or she should use a separate IRA.
IRAs may be rolled over only once every 12 months. This 12-month waiting period can be avoided, however, if there is a transfer from the trustee or custodian of one IRA to another (as in a fund switch from one family of mutual funds to another).
The surviving spouse of the IRA owner—and only the surviving spouse—is permitted to roll over the IRA proceeds following the IRA owner's death. Surviving spouses are also permitted to roll over qualified retirement plan distributions to an IRA.
An individual who is age 70½ or over may generally only roll over or transfer a qualified retirement plan distribution or IRA balance to the extent it exceeds the required minimum distribution.
The funds rolled over or directly transferred will continue to accumulate earnings on a tax-deferred basis after the rollover.
Any taxable amounts distributed to the plan participant but not rolled over properly are taxable in the year distributed. If made before age 59½, the distribution may be subject to a 10% penalty in addition to the regular income tax, unless an exception applies.
Under prior law, distributions from an IRA generally could not be rolled over except to another IRA.
Effective for distributions on and after January 1, 2002, distributions from an IRA may be rolled over to a qualified plan, 403(b) plan or 457(b) governmental plan. However, the following amounts may not be rolled over from an IRA to a qualified plan, 403(b) plan or 457(b) governmental plan:
after-tax amounts;
required minimum distributions;
substantially equal periodic payments made over life (or life expectancy) or joint lives (or life expectancies) of the participant or IRA owner, or over a period of 10 years or more; and
distributions to beneficiaries (other than spousal beneficiaries) from inherited IRAs.
Under prior law, the maximum amount of a tax-free rollover was the portion of a distribution that was taxable. As a result, when a distribution consisted in part of after-tax contributions that were nontaxable to the recipient, these after-tax contributions could not be rolled over to an IRA or qualified plan, where they could continue to enjoy tax-deferred earnings. This was true of direct rollovers (direct trustee-to-trustee transfers) as well as rollovers that passed through the recipient's hands and were rolled over within 60 days.
Effective for distributions made on and after January 1, 2002, the after-tax portion of a distribution may be rolled over on a tax-free basis, provided the rollover is to an IRA or a defined contribution plan. If the rollover is to a defined contribution plan, the receiving plan must agree to account separately for the taxable and nontaxable portions.
Note that an IRA that receives a rollover of after-tax contributions is apparently not required to account separately for the taxable and nontaxable portions, as is a defined contribution plan receiving the rollover. Effective for distributions made after December 31, 2006, distributions of after-tax contributions (and earnings) from a qualified plan may also be rolled over to a 403(b) plan or to a qualified defined benefit plan, provided that the recipient plan separately accounts for rolled over after-tax contributions and earnings thereon.
Nontaxable amounts distributed from a qualified retirement plan still may not be rolled over to a Section 457(b) plan, even though it is arguably an "individual account defined contribution plan."
The after-tax portion of an IRA distribution may be rolled over to another IRA, but not to a qualified plan.
IRS Notice 2014-54 clears a way for an individual to split a single distribution from an employer-sponsored retirement plan between two IRAs without the need of complex distribution strategies. This guidance is intended to benefit individuals who have made both pre-tax and after-tax contributions to a retirement plan and want to move pre-tax amounts to a traditional IRA and after-tax amounts to a Roth IRA. The plans most likely to be affected by this guidance are 401(k), 403(b) and 457(b) plans that allow (or allowed) participants to make contributions on an after-tax basis. Notice 2014-54 does not change the requirement that each distribution from a plan must include a proportional share of the pre-tax and after-tax amounts. It is not possible, for example, to take a distribution of only after-tax amounts from a 401(k) plan and leave pre-tax amounts in the plan.
In order to split a distribution, the participant must:
request that the plan administrator distribute (and report on Form 1099-R) the funds in accordance with their respective tax treatments, and
schedule the transfers to occur simultaneously.
Note the importance of these critical steps. Failure to meet either requirement precludes a participant from benefiting from the rule change.
Bear in mind that after-tax contributions predate the advent of Roth IRAs and do not share Roth rules. Many plans now allow Roth contributions, which are also made on an after-tax basis but continue to grow tax free. The after-tax contributions referred to in IRS Notice 2014-54 do not grow tax free, and taxable earnings must be accounted for and allocated in accordance with the Notice. However, once rolled into a Roth IRA, future earnings on the after-tax contributions will not be taxed.
The rule changes generally apply to distributions on or after January 1, 2015.
Under prior law, distributions from a Section 457(b) plan were not eligible for a tax-free rollover to an IRA. However, tax-free transfers from one Section 457(b) plan to another were permitted if the plans of both employers so allowed.
Effective for distributions on and after January 1, 2002, distributions from 457(b) plans maintained by a governmental employer may be rolled over to an IRA or to a qualified plan (including a 401(k) plan), 403(b) plan or another 457(b) governmental plan.
Portability of benefits has not been extended to participants in Section 457(b) plans maintained by not-for-profit organizations, which remain subject to the restrictions of prior law, since these plans are not required to be trusteed.
To avoid current income taxation of a distribution received from a tax-qualified plan or account, the recipient generally must roll over the distribution into another plan or IRA within 60 days of receiving the distribution. Under prior law, the IRS only had discretion to waive the 60-day requirement in cases of military service in a combat zone, or in cases of a natural disaster when so declared by the president.
In the Economic Growth and Tax Relief Reconciliation Act of 2001, Congress instructed the IRS to issue guidelines under which the normal 60-day requirement would be waived in hardship cases. The IRS responded in Rev. Proc. 2003-16, 2003-4 IRB 305. The 60-day rollover period will be waived automatically in certain cases of financial institution error, and case-by-case in all other situations, based on IRS review of the facts and circumstances.
To qualify for the automatic waiver, four requirements must be met:
The taxpayer received a distribution on or after Jan. 1, 2002.
In the 60-day period, the taxpayer transferred the funds to a financial institution and did everything the institution required to deposit the funds into an eligible retirement plan.
Due solely to an error by the financial institution, the funds were not in fact deposited into an eligible retirement plan within the 60-day period.
The funds were deposited into an eligible retirement plan within one year of the original distribution.
The IRS has issued several private letter rulings waiving the 60-day rollover period for particular taxpayers where errors by banks or investment managers, or the mental disabilities of IRA owners, prevented them from complying with the 60-day requirement [see Rev. Proc. 2003-16, 2003-4 I.R.B. 359].
The surviving spouse of a plan participant can make a tax-free rollover of a distribution from the account of a deceased participant in a qualified employer retirement plan to an IRA, a qualified plan, 403(b) annuity plan, or governmental 457(b) plan in which the spouse participates.
This special treatment accorded to surviving spouses does not extend to other beneficiaries. However, it is consistent with other special exceptions for surviving spouses, such as the one that permits them to elect to treat a deceased spouse's IRA as their own [Reg. Sec. 1.408-8, Q&A A-5(a)], which can enable a surviving spouse to stretch out the period over which they must take minimum distributions from the IRA.
Effective for death benefit distributions made after December 31, 2006, to non-spouse designated beneficiaries under qualified plans, 403(b) annuities, or governmental 457(b) plans, such death benefit distributions may be transferred directly to an IRA, subject to the following conditions:
The payment must be in the form of a direct trustee-to-trustee transfer (i.e., no 60-day rollover).
The payment must be made to an IRA that is established solely to receive the death benefit. The IRA must be established in a manner that identifies it as an IRA with respect to a deceased individual. It must identify the deceased individual and the beneficiary, for example, "Tom Smith as beneficiary of John Smith, deceased."
The IRA will be subject to the minimum distribution rules that apply to beneficiaries.
No rollovers are permitted from the IRA that receives the death benefit distribution.
Note: The Worker, Retiree and Employer Recovery Act of 2008 requires plans to offer a direct rollover of a distribution to a nonspouse beneficiary.
A qualified plan may distribute the entire account balance or accrued benefit of a participant who has terminated employment, without the consent of the employee, if the present value of the account or benefit is $5,000 or less. This cash-out rule discourages plans from accepting rollover contributions, and thus discourages portability of benefits when a participant changes employers.
For purposes of the cash-out rule, employer plans may disregard rollover contributions, and any earnings thereon, in determining the value of a participant's nonforfeitable accrued benefit. This applies to distributions on and after January 1, 2002.
This change may persuade some employers to amend their plans to allow them to accept rollover contributions from other plans.
A qualified plan may distribute the entire account balance or accrued benefit of a participant who has terminated employment, without the consent of the employee, if the present value of the account or benefit is $5,000 or less. Mandatory cash-outs of separating employees may be rolled over to an IRA or another qualified plan. However, one study found that over two-thirds of 401(k) participants declined to roll over their accounts when changing jobs.
A direct rollover is the default option when a participant is involuntarily cashed out of a plan and the distribution exceeds $1,000, but does not exceed $5,000. The distribution will be rolled over automatically to an IRA established in the name of the participant, unless the participant makes an affirmative election to have the distribution rolled elsewhere or taken directly in cash.
New automatic direct rollover default rules became effective on March 28, 2005, for cash-out distributions from a qualified retirement plan. Specifically, if a qualified plan makes a distribution of a vested accrued benefit of less than $5,000 but more than $1,000, and if the distributee does not make an election to have the distribution paid to another qualified plan or IRA and does not elect to receive the distribution directly, the plan administrator must transfer the amount of the distribution to a designated IRA set up for the distributee. The plan administrator must also notify the distributee that he or she can elect to have the distribution transferred to a different IRA or qualified plan or to receive the distribution directly.
All hardship distributions from 401(k) and 403(b) plans made on and after January 1, 2002, are ineligible for rollover. The distributions are subject to withholding unless the employee elects not to have withholding apply. Previously, employer matching contributions distributed on account of hardship were eligible for rollover (although not employee elective deferrals).
The administrator of a qualified plan or 403(b) plan must provide a written notice of the rollover rules to participants who receive an eligible rollover distribution [IRC Sec. 402(f)]. The notice must be provided before the distribution is received and must explain the direct rollover option, the withholding tax consequences of not doing a direct rollover, and the 60-day period for accomplishing a tax-free rollover. Penalties apply to administrators who fail to meet this notice obligation.
The administrator's written notice will also have to include an explanation of how the recipient plan of a rollover distribution may be subject to different tax rules and restrictions than the source plan.
The IRS released two model, safe harbor explanations to satisfy the IRC Sec. 402(f) notice requirements in IRS Notice 2002-3, as updated by IRS Notice 2009-68. One explanation covers distributions from Section 457(b) governmental plans, and the other covers distributions from all other plans. The model explanations set forth in these Notices apply to distributions made prior to January 1, 2015. IRS Notice 2014-74 outlines new changes required to the 402(f) notification and includes revised model notices. The rule changes generally apply to distributions on or after January 1, 2015.
Distributions, if properly rolled over or transferred, are not subject to current federal income taxation (except for the withholding on rollovers or transfers that are not direct).
Rolled-over or transferred amounts will continue to accumulate earnings on a tax-deferred basis until eventually distributed.
An IRA owner who takes a distribution from an IRA is generally allowed to roll the money to another IRA within 60 days without being taxed on the distribution. This is sometimes called an "indirect rollover" to distinguish it from a rollover from an eligible plan to an IRA.
Two IRS developments require advisors to reconsider how they advise IRA owners with respect to how often owners can make indirect rollovers. The IRS has taken the position that such rollovers may only be made once in any 12-month period regardless of the number of IRAs an individual maintains.
This change comes as a result of the decision in Bobrow v. Commissioner, T.C. Memo. 2014-21, followed quickly by IRS Announcement 2014-15. Prior to the conclusions in these rulings, it was widely understood, based on IRS guidance, that the "once per 12-month period" rollover rule applied on a "per-IRA" basis, meaning that an individual with five IRAs, for example, could make up to five IRA rollovers in any 12-month period (one for each IRA). The IRS no longer takes this view, and will withdraw proposed rollover regulations, revise Publication 590 and issue new proposed regulations to the extent needed to follow their new position.
Note that the ability to transfer funds electronically between IRAs (a "direct rollover") has not been affected. Thus, an IRA owner who does not actually receive a distribution of IRA assets may electronically transfer funds between IRA custodians as many times as desired.
Before leaving a company or retiring, then, it is essential that an employee arrange the desired distribution procedure. The employee can avoid withholding by:
leaving the money in the employer's plan, if allowed under the terms of the plan; or
arranging for the direct transfer of funds to an IRA or eligible qualified retirement plan that accepts rollovers.
If the employee makes either of these arrangements, no tax is due and the funds can continue to generate tax-deferred earnings. However, if the employer cuts a check for the employee's lump-sum benefit, the 20% withholding will automatically be deducted for federal income tax purposes.
Copyright 
2016, Pentera Group, Inc., 921 East 86th Street, Suite 100, Indianapolis, Indiana 46240. All rights reserved.
This service is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that neither the publisher nor any of its licensees or their distributees intend to, or are engaged in, rendering legal, accounting, or tax advice. If legal or tax advice or other expert assistance is required, the services of a competent professional should be sought.
While the publisher has been diligent in attempting to provide accurate information, the accuracy of the information cannot be guaranteed. Laws and regulations change frequently, and are subject to differing legal interpretations. Accordingly, neither the publisher nor any of its licensees or their distributees shall be liable for any loss or damage caused, or alleged to have been caused, by the use of or reliance upon this service.
Click for information related to duties and responsibilities of plan administrators regarding rollovers.