How Can You Avoid the 5 Most Common Rollover Mistakes?

By SunAmerica

Tips to Help You Avoid the 5 Most Common Rollover Mistakes?

 

Pitfall #1: Not rolling assets over on time

For an indirect rollover to be tax-free, you must roll the assets into another IRA or plan within 60 days. Miss this deadline and you could pay federal and state income taxes of up to 45%, plus a 10% federal tax penalty on the taxable amount if you are under age 59½.*

How to avoid it: 

  • Simply transfer or roll assets directly into another IRA or plan
  • There are no taxes if you don’t take control of your money. (By definition, indirect rollovers involve temporarily taking control of your assets.)

*   You could pay federal income tax rate of up to 35% and state income tax of 9.5%, depending on the state. For indirect rollovers to be tax-free, additional restrictions and limitations may apply. Please consult with your tax advisor regarding your individual situation.

 

Pitfall #2: Not rolling over the same assets

An indirect rollover from an IRA is only tax-free if the same property is rolled over within the 60-day period. You cannot withdraw stocks, sell them and then roll over the cash—if you do, the entire distribution amount becomes taxable.

How to avoid it:  

  • Don’t make rollovers more complicated than they need to be
  • Keep it simple by transferring or rolling the same assets directly into a new IRA or plan

 

Pitfall #3: Rolling assets indirectly from an employer-sponsored plan

For indirect rollovers from an employer-sponsored plan, the company must withhold 20% of the taxable amount, even if your intent is to roll over all of the assets within 60 days.

How to avoid it: 

  • Your rollover will be tax-free if you replace the 20% withheld with outside money and then roll 100% of the assets into another IRA or plan
  • Or you can simply avoid the tax withholding requirement by electing a transfer or direct rollover

 

Pitfall #4: Rolling assets over too soon

If you are under age 59½ and roll your 401(k) assets into an IRA, you won’t be able to take out money from the IRA without paying a 10% tax penalty. The exception is if your rollover contains post-tax contributions that are not subject to the early withdrawal tax penalty.

How to avoid it: 

  • Consider keeping the assets in your employer-sponsored plan until you reach age 59½
  • The 10% tax penalty won’t apply, as long as you have left the company and the separation occurs during or after the calendar year in which you reached age 55. Of course, this is only applicable if your assets remain in a retirement plan sponsored by the employer from which your post-55 separation from service occurred.

 

Pitfall #5: Rolling highly appreciated company stock into IRAs

An IRA rollover is tax-free, but once the stocks are sold, you could pay ordinary income tax of up to 35% on the entire distribution amount. (The top marginal federal income tax rate is currently 35%).

How to avoid it:  

  • Reduce taxes by transferring highly appreciated stocks into a taxable account using the Net Unrealized Appreciation (NUA) Strategy. When you use this strategy, you are responsible for income tax on the original purchase price (cost basis) of the stock when it’s moved to the taxable account, but you will pay only up to 15% on the NUA when the stocks are sold. Ask your financial advisor about how this strategy can be employed.
  • Please keep in mind that you should only use the NUA tax break strategy if the company stock is highly appreciated. Because tax is paid on the withdrawal at ordinary income tax rates, the NUA must be significantly higher for the strategy to pay off.

 

Important Note: SunAmerica does not provide investment or tax advice. The information above should not be considered to be advice. Please consult with your financial advisor and/or tax advisor regarding your particular situation.