Do you have a retirement plan from a previous employer that you have left with the employer after separating from service? Once you leave your employer, you do have the ability to move qualified retirement accounts. There are two ways to accomplish this. You can do a transfer or a direct rollover. You will want to move any tax-deferred accounts such as pre-tax 401(k), 403(b), and 457 to another tax-deferred account. Any post-tax or Roth 401(k) accounts, you will want to move into a Roth IRA.
By moving a pre-tax account to a Traditional IRA, you avoid having to pay any taxes currently. By moving a Roth account to a Roth IRA, you will maintain the tax-free status of the funds.
A direct transfer goes directly from the old employer plan to the new retirement account. You do not have access to the funds. By doing a direct rollover, you avoid the mandatory 20% withholding on any distribution. There are no limits on how many direct rollovers you can do each year. If you have 5 qualified retirement accounts that you would like to combine, you can move them all in one year if you do direct rollovers. Some institutions will send the check directly to the new institutions. Some will send the check to you, but it will be made payable to the new institution and considered a direct rollover.
A transfer is sent to you and made payable to you. You have 60 days to get the funds into the retirement account. If you do not get the funds into the new account within 60 days, the distribution will be fully taxable. If you only put part of the funds into the new retirement account than you received, you will pay tax on the difference.
You are only allowed one transfer in any 365-day period. If you have 5 qualified retirement accounts, you can only do one transfer in each 365-day period. These are 365-day periods, not calendar years. If you receive the funds for more than one account via a transfer, you will be subject to tax and penalties.
Distributions from pre-tax or tax-deferred retirement plans can have a penalty attached if you take distributions before reaching 59 ½ years of age. The penalty is a 10% penalty that is assessed on your tax return in the year the distribution was taken. There are some exceptions to the penalty.
The penalty can be waived for an employer plan distribution made to an employee after separating from service in or after the year they reach age 55 or age 50 for a qualified public safety employee. This exception does not hold true for IRAs. If you are between 55 and 59 ½, give careful consideration before you roll those funds out of your employer plan to an IRA. If you are going to need some of the funds within that time frame, you may want to leave the funds in the employer’s plan.
The penalty can be waived If you become totally and permanently disabled, a death occurs, or to cover unreimbursed medical expenses that exceed 7.5% of your adjusted gross income. Distributions from a qualified plan made to an ex-spouse in a divorce settlement, known as qualified domestic relations order (QDRO), are not subject to the 10% penalty.
The penalty exceptions are different for IRAs and employer-sponsored plans. For IRAs, distributions to pay health insurance premiums to certain unemployed individuals or qualified higher education expenses certain individuals will not be subject to the penalty. Qualified distributions for first-time home purchase out of an IRA account will have the penalty waived. You must not have owned a home in the prior two years to qualify for this exclusion, and the exception to the penalty is limited to $10,000 lifetime.
Distributions paid directly to the IRS for an IRS levy have an exception for both IRAs and qualified plans. The exception will not apply if the funds are withdrawn. While serving on active duty for at least 180 days, reservists who take distributions from a qualified plan or an IRA will qualify for an exception. There is an exception for distributions taken out of a qualified plan or IRA of up to $5,000 for expenses to adopt a child. You can currently take a distribution of up to $100,000 without penalty if it is for a qualified disaster and or related to coronavirus.
Another option to avoid the 10% penalty is setting up a 72(t) distribution. Rule 72(t) allows you to take money from your qualified retirement account or IRA before reaching 59 ½. You must take substantially equal period payments for five years or until the owner reaches 59 ½, whichever period is longer. If you are 50 years old and need to use the 72(t) rules, you would need to take distributions until you turn 59 ½. If you were 56, you would need to take distributions for 5 years or age 61.
Many people are currently experiencing hardships due to COVID-19 and unemployment. There are some special rules to allow you to take distributions and put funds back in over three years to avoid both tax and penalty.
Taking distributions from your retirement accounts may help with a financial need today. It can also jeopardize retirement later. Consider other available options before using your retirement dollars. Need help on deciding if and how to move old employer plans? Do you need to take a distribution and want to discuss the best way to accomplish that without penalty? Give Planning with Purpose a call to get help in getting accounts consolidated or get you the funds you need!
