Common Rollover Mistakes in Retirement Planning
Sometimes, this involves a change in your retirement plans. You might have decided to diversify your holdings and buy assets like bitcoin as part of your retirement savings. You may be choosing to modify your retirement strategy or re-evaluate all of your finances, or maybe you’re changing your employer and that’s forcing you to re-consider your existing plans. Odds are, a transfer or rollover will be involved.
Without awareness of the associated rules, the process of rolling over funds from one account into another is where many mistakes occur. As Andrew Meadows, senior vice president of Ubiquity Retirement + Savings, noted in an interview with Money.com:
“We do not make rolling over your money very easy. It takes, in many cases, a paper form. We need your signature. You have to mail it in with snail mail and wait for 30 days or so until it processes. You get a check written out not to you but to a retirement account… it’s really an arduous process when you’re looking at thousands of dollars you worked really hard to save.”
Looking at the common mistakes people tend to make when they roll over funds between their retirement accounts can help you make better decisions about your retirement strategy.
This article provides some background, but it’s not intended as advice. Always consult with a certified financial professional for information regarding your specific situation.
However, you may be able to ask them better questions if you’re aware of the types of issues that tend to arise in moving funds between retirement accounts.
Mistake #1: Missing the Deadline to Roll Over Assets
When leaving a job, many people—motivated by factors like high maintenance fees or limited investment options—choose to rollover their 401(k) or other retirement plans.
Depending on the terms of your plan, you’ll likely be able to choose between a direct or indirect rollover.
- In a direct rollover, the money is transferred directly between accounts without ever entering your hands. Any tax-deferment in place remains intact.
- In an indirect rollover, you are issued a check for the funds in the retirement plan, which you must deposit in another retirement account within a set amount of time or else you will face taxes and possibly penalties.
An indirect rollover might be tempting for your situation, including if you are strapped for cash and would like to give yourself a short-term loan.
In the event of an indirect rollover, the IRS generally gives 60 days for you to move that money into another account. If you fail to move those funds within 60 days, the IRS considers that check to be a distribution or withdrawal, which means that taxes are owed on that money. And if you are under the age of 59½, you will also pay an early withdrawal penalty that is usually 10% on top of your tax bill.
Unfortunately, it’s easy to make this mistake. As Meadows noted in the above quote, half of this 60-day period can be taken up by just waiting for your rollover to process. What’s more stressful is that often this money move comes at the same time as your either looking for work or trying to settle into a new job.
One easy way to avoid having to deal with this 60-day time limit is to ask for a direct rollover or transfer of funds. If you have the option, don’t request a check at all. See if you can transfer funds from your old account into a new one.
Mistake #2: Paying an Extra 20% For an Indirect Rollover
When an indirect rollover is initiated from an employer-sponsored plan, the employer must withhold 20% of the taxable amount of the rollover.
This means that in order to avoid incurring extra tax penalties for an indirect rollover, not only do you need to meet the 60-day deadline, but you will also need to shell out an additional 20% to compensate for what the employer is required to withhold. Otherwise, you will not be able to move the entire fund amount over within the required 60-day window.
If you successfully complete this rollover, the 20% that was withheld will be returned to you when you file your taxes for that year.
But for many individuals, having to compensate for the 20% withheld within 60 days is too much to ask, and negates the benefits of the temporary 60-day “loan” that effectively results from an indirect rollover.
Mistake #3: Rolling Over Assets Too Early
While waiting too long to make a rollover is one serious mistake, trying to roll over funds too early is another.
There are some specific scenarios under which this mistake is often made:
- The One-Year Rule – While you only have 60 days to process a rollover, you have to wait a full 365 days before your next rollover. The penalties for this are the same as failing the 60-day rule. The amount you roll over when you break this rule is taxed as a distribution (your ordinary income tax rate) and penalized if you are younger than 59½.
- The Five-Year Rule (Roth IRAs) –From January 1st of the year you make your first contribution to a Roth IRA, you generally have to wait at least five years before you can withdraw earnings from This five-year rule applies to rollovers too.With a few exceptions, if you withdraw earnings from a Roth IRA before the mandatory five years have passed, you will have to pay income taxes on that withdrawal as well as an early withdrawal penalty.As noted, there are some exceptions to this rule, although none of them allow you to roll over or transfer funds to another account.
- Up to $10,000 may be withdrawn from a Roth IRA to pay for a first home or for higher education for a spouse, child, or grandchild.
- If you are unemployed, you may withdraw funds to pay for health insurance.
- If you incur medical expenses greater than 10% of your adjusted gross income (AGI), you may reimburse yourself.
- Two-Year Rule (SIMPLE IRAs) – For the first two years that you own a SIMPLE IRA, you cannot take an early distribution or move them into another retirement plan without facing a steep 25% tax penalty.The IRS does allow for a few extenuating circumstances to exempt individuals from this tax penalty. Regardless of extenuating circumstances, there is one exception to this two-year rule: you are allowed to transfer funds from one SIMPLE IRA into another SIMPLE IRA within the first two years.
The simplest way around making these mistakes is to discuss any potential rollover or transfer with both plan/account administrators. Before moving any money around, determine what options you have and make sure that your actions work positively for your retirement goals.
Mistake #4: Rolling Over Different Assets
Whether direct or indirect, in order for a rollover to be tax-free, the same type of property must be rolled over within the 60-day window.
You cannot withdraw the funds as cash from one account and then try to roll over anything bought with that money into another account. For example, you can’t take cash out of one IRA, buy cryptocurrency, and then try to put that crypto into an IRA. (You can, however, roll over funds from an eligible IRA into a self-directed IRA, and then, within that IRA, purchase cryptocurrency.)
If you break this rule, the original withdrawal or distribution will be taxed at your standard income tax rate. If you are under the age 59½, you will likely face additional tax penalties.
The easiest way to avoid this mistake is to directly transfer funds or assets between accounts. Our Digital IRA Specialists can walk you through this process.
Mistake #5: Rolling Over IRA Funds More Than Once Per Year
For 2015, the IRS announced that it would no longer allow more than one IRA-to-IRA rollover per 12-month period.
What happens if you break this rule? The funds moved are considered to be a distribution, which makes them taxable and potentially subject to additional penalties depending on factors including your age. Additionally, you might face excess contribution penalties if they are placed into an IRA.
The good news is that this limit applies to each separate IRA account. This means that if you own multiple IRAs, you can move funds stored in each of them around; you just cannot move the same sum of money around more than once per year.
The best way around this rule is a direct transfer between trustees. You can carry out as many direct transfers per year as you would like, without facing any restrictions or penalties.
Mistake #6: Rolling Over RMDs
Sometimes, people take their required minimum distribution (RMD) and try to convert them into Roth IRAs since they have already paid taxes on the funds.
Given the way the tax law is written, this cannot be done.
The IRS does not allow you to place your RMD into another tax-advantaged account. If you try to do this, your RMD will be treated as an excess contribution and you will be charged a 6% penalty for every year it remains in an IRA.
Most of the time, you will avoid facing these problems if you opt for a direct transfer wherever possible. Always be sure to consult with your plan/account administrators and a tax professional for advice tailored to your particular situation.