What Are the Tax Implications of a Rollover IRA?

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An IRA rollover normally is a transfer of funds directly from one tax-deferred retirement saving plan, such as an employer-sponsored 401k, to another qualified tax-deferred retirement plan, such as an Individual Retirement Account (IRA). Such rollovers, says the Phoenix Companies’ financial website, are tax-free transactions. But there are some types of IRA rollovers that have tax consequences.

Potential Problems

Tax consequences may occur if you do what’s called an indirect rollover, states the Phoenix website. In an indirect rollover, the distribution is paid to you and you have up to 60 days to put that distribution into your rollover retirement account.

Withholding Done

A tax complication arises because the distribution is being paid to you rather than directly to your rollover retirement account. When a distribution is paid to you, the fiduciary must withhold 20 percent for income taxes regardless of your intent to put the money into another IRA. So you only will get 80 percent of your distribution to roll over.

Make-up Mandatory

To avoid taxes on your indirect rollover, you must make up the 20 percent withholding from other funds to complete the rollover within the 60-day time window. Otherwise, the entire distribution will be treated as taxable income, says the Phoenix website.

Roth Rollovers

If you are planning a rollover from a 401k plan or traditional IRA to a Roth IRA, you will face tax consequences, says the IRA Rollover Rules website. Traditional IRAs and 401k plans use before-tax dollars, while Roth IRAs use after-tax dollars. You must pay taxes on the distribution from the 401k or traditional IRA even if you are directly rolling over to the Roth IRA. But once your funds are in the Roth IRA, your retirement savings will grow tax-free.

References

About the Author

Herb Kirchhoff has more than three decades of hands-on experience as an avid garden hobbyist and home handyman. Since retiring from the news business in 2008, Kirchhoff takes care of a 12-acre rural Michigan lakefront property and applies his experience to his vegetable and flower gardens and home repair and renovation projects.

Photo Credits

  • Stacks of One Hundred Dollar Bills on a Black Background. image by Andy Dean from Fotolia.com